The Foshan NationStar Optoelectronics Co.,Ltd (SZSE:002449) share price has fared very poorly over the last month, falling by a substantial 26%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 24% in that time.

Even after such a large drop in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 30x, you may still consider Foshan NationStar OptoelectronicsLtd as a stock to avoid entirely with its 55.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For example, consider that Foshan NationStar OptoelectronicsLtd'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. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for Foshan NationStar OptoelectronicsLtd

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Foshan NationStar OptoelectronicsLtd's to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 56%. This means it has also seen a slide in earnings over the longer-term as EPS is down 54% in total over the last three years. 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 42% 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 Foshan NationStar OptoelectronicsLtd is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

What We Can Learn From Foshan NationStar OptoelectronicsLtd's P/E?

A significant share price dive has done very little to deflate Foshan NationStar OptoelectronicsLtd's very lofty P/E. 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 Foshan NationStar OptoelectronicsLtd 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. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider and we've discovered 4 warning signs for Foshan NationStar OptoelectronicsLtd (1 is a bit concerning!) that you should be aware of before investing here.

Of course, you might also be able to find a better stock than Foshan NationStar OptoelectronicsLtd. 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.