Unfortunately for some shareholders, the ADD Industry (Zhejiang) CO., LTD (SHSE:603089) share price has dived 25% in the last thirty days, prolonging recent pain. Longer-term shareholders would now have taken a real hit with the stock declining 8.4% in the last year.

Even after such a large drop in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may still consider ADD Industry (Zhejiang) as a stock to potentially avoid with its 35x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

As an illustration, earnings have deteriorated at ADD Industry (Zhejiang) over the last year, which is not ideal at all. 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.

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

The only time you'd be truly comfortable seeing a P/E as high as ADD Industry (Zhejiang)'s is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a frustrating 31% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 47% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 42% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that ADD Industry (Zhejiang)'s P/E sits above the majority of other companies. 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 good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On ADD Industry (Zhejiang)'s P/E

There's still some solid strength behind ADD Industry (Zhejiang)'s P/E, if not its share price lately. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of ADD Industry (Zhejiang) revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 4 warning signs for ADD Industry (Zhejiang) (1 is significant) you should be aware of.

You might be able to find a better investment than ADD Industry (Zhejiang). If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.