Sichuan Dowell Science and Technology Inc. (SZSE:300535) shareholders that were waiting for something to happen have been dealt a blow with a 30% share price drop in the last month. The recent drop has obliterated the annual return, with the share price now down 8.3% over that longer period.

Even after such a large drop in price, Sichuan Dowell Science and Technology's price-to-earnings (or "P/E") ratio of 63.4x might still make it look like a strong 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. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Sichuan Dowell Science and Technology has been doing a good job lately as it's been growing earnings at a solid pace. One possibility is that the P/E is high because investors think this respectable earnings growth will be 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.

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

In order to justify its P/E ratio, Sichuan Dowell Science and Technology would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 18%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 54% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 42% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Sichuan Dowell Science and Technology's P/E sits above 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. 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

Even after such a strong price drop, Sichuan Dowell Science and Technology's P/E still exceeds the rest of the market significantly. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Sichuan Dowell Science and Technology 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. 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.

It is also worth noting that we have found 2 warning signs for Sichuan Dowell Science and Technology (1 shouldn't be ignored!) that you need to take into consideration.

If you're unsure about the strength of Sichuan Dowell Science and Technology's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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