Those holding Zhiyang Innovation Technology Co., Ltd. (SHSE:688191) shares would be relieved that the share price has rebounded 30% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

Although its price has surged higher, you could still be forgiven for feeling indifferent about Zhiyang Innovation Technology's P/E ratio of 30.2x, since the median price-to-earnings (or "P/E") ratio in China is also close to 32x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

For example, consider that Zhiyang Innovation Technology's financial performance has been poor lately as it's earnings have been in decline. One possibility is that the P/E is moderate because investors think the company might still do enough to be in line with the broader market in the near future. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

See our latest analysis for Zhiyang Innovation Technology

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

In order to justify its P/E ratio, Zhiyang Innovation Technology would need to produce growth that's similar to the market.

Retrospectively, the last year delivered a frustrating 19% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 2.5% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 38% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's somewhat alarming that Zhiyang Innovation Technology's P/E sits in line with the majority of other companies. 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 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 Final Word

Zhiyang Innovation Technology's stock has a lot of momentum behind it lately, which has brought its P/E level with the market. 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 Zhiyang Innovation Technology revealed its shrinking earnings over the medium-term aren't impacting its P/E as much as we would have predicted, given the market is set to grow. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You need to take note of risks, for example - Zhiyang Innovation Technology has 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20x).

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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.