Doright Co.,Ltd. (SZSE:300950) shareholders that were waiting for something to happen have been dealt a blow with a 27% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 37% share price drop.

Although its price has dipped substantially, DorightLtd's price-to-earnings (or "P/E") ratio of 33.9x might still 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 27x and even P/E's below 17x are quite common. 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 DorightLtd's financial performance has been poor lately as its earnings have been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Does Growth Match The High P/E?

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

Retrospectively, the last year delivered a frustrating 22% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 13% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 42% shows it's an unpleasant look.

With this information, we find it concerning that DorightLtd 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. 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 DorightLtd's P/E

There's still some solid strength behind DorightLtd's P/E, if not its share price lately. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that DorightLtd 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. 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.

There are also other vital risk factors to consider and we've discovered 2 warning signs for DorightLtd (1 shouldn't be ignored!) that you should be aware of before investing here.

Of course, you might also be able to find a better stock than DorightLtd. 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.