Despite an already strong run, Edan Instruments, Inc. (SZSE:300206) shares have been powering on, with a gain of 26% in the last thirty days. Taking a wider view, although not as strong as the last month, the full year gain of 24% is also fairly reasonable.

After such a large jump in price, Edan Instruments' price-to-earnings (or "P/E") ratio of 49x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 36x and even P/E's below 21x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Edan Instruments over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Growth Metrics Telling Us About The High P/E?

Edan Instruments' P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 44%. As a result, earnings from three years ago have also fallen 42% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 39% shows it's an unpleasant look.

With this information, we find it concerning that Edan Instruments is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Bottom Line On Edan Instruments' P/E

Edan Instruments' P/E is getting right up there since its shares have risen strongly. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Edan Instruments currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you settle on your opinion, we've discovered 3 warning signs for Edan Instruments (1 is significant!) that you should be aware of.

If these risks are making you reconsider your opinion on Edan Instruments, explore our interactive list of high quality stocks to get an idea of what else is out there.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.