The Yangzhou Chenhua New Material Co., Ltd. (SZSE:300610) share price has fared very poorly over the last month, falling by a substantial 28%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 41% in that time.

In spite of the heavy fall in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may still consider Yangzhou Chenhua New Material as a stock to potentially avoid with its 40.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times haven't been advantageous for Yangzhou Chenhua New Material as its earnings have been falling quicker than most other companies. It might be that many expect the dismal earnings performance to recover substantially, 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.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Yangzhou Chenhua New Material would need to produce impressive growth in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 72%. As a result, earnings from three years ago have also fallen 65% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 218% during the coming year according to the three analysts following the company. That's shaping up to be materially higher than the 41% growth forecast for the broader market.

With this information, we can see why Yangzhou Chenhua New Material is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On Yangzhou Chenhua New Material's P/E

Yangzhou Chenhua New Material's P/E hasn't come down all the way after its stock plunged. 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 Yangzhou Chenhua New Material maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Yangzhou Chenhua New Material (1 is a bit unpleasant) you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.