With a price-to-earnings (or "P/E") ratio of 40.1x Shandong Dawn Polymer Co.,Ltd. (SZSE:002838) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 32x and even P/E's lower than 20x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Shandong Dawn PolymerLtd's financial performance has been poor lately as its earnings have been in decline. 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?

There's an inherent assumption that a company should outperform the market for P/E ratios like Shandong Dawn PolymerLtd's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 1.1%. As a result, earnings from three years ago have also fallen 85% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 39% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Shandong Dawn PolymerLtd is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Shandong Dawn PolymerLtd's P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Shandong Dawn PolymerLtd currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Shandong Dawn PolymerLtd that you should be aware of.

You might be able to find a better investment than Shandong Dawn PolymerLtd. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.