Dragon Rise Group Holdings Limited (HKG:6829) shareholders would be excited to see that the share price has had a great month, posting a 39% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 39% over that time.

Following the firm bounce in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Dragon Rise Group Holdings as a stock to avoid entirely with its 42.1x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

For instance, Dragon Rise Group Holdings' receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

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

There's an inherent assumption that a company should far outperform the market for P/E ratios like Dragon Rise Group Holdings' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 49% decrease to the company's bottom line. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

This is in contrast to the rest of the market, which is expected to grow by 22% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Dragon Rise Group Holdings' P/E sits above the majority of other companies. 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. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

What We Can Learn From Dragon Rise Group Holdings' P/E?

The strong share price surge has got Dragon Rise Group Holdings' P/E rushing to great heights as well. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Dragon Rise Group Holdings currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It is also worth noting that we have found 5 warning signs for Dragon Rise Group Holdings (3 make us uncomfortable!) that you need to take into consideration.

Of course, you might also be able to find a better stock than Dragon Rise Group Holdings. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.