NanJing AoLian AE&EA Co.,Ltd (SZSE:300585) shareholders that were waiting for something to happen have been dealt a blow with a 35% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 12% in that time.

Even after such a large drop in price, NanJing AoLian AE&EALtd may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 78.7x, since almost half of all companies in China have P/E ratios under 26x and even P/E's lower than 16x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, NanJing AoLian AE&EALtd's 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for NanJing AoLian AE&EALtd

How Is NanJing AoLian AE&EALtd's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as NanJing AoLian AE&EALtd's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 48%. The last three years don't look nice either as the company has shrunk EPS by 39% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 35% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that NanJing AoLian AE&EALtd 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.

The Key Takeaway

NanJing AoLian AE&EALtd's shares may have retreated, but its P/E is still flying high. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of NanJing AoLian AE&EALtd revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. 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.

You need to take note of risks, for example - NanJing AoLian AE&EALtd has 5 warning signs (and 1 which is significant) we think you should know about.

If these risks are making you reconsider your opinion on NanJing AoLian AE&EALtd, 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.