Jiangsu Huaxin New Material Co.,Ltd. (SZSE:300717) shareholders that were waiting for something to happen have been dealt a blow with a 29% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 21% share price drop.

In spite of the heavy fall in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may still consider Jiangsu Huaxin New MaterialLtd as a stock to potentially avoid with its 35.8x 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.

For example, consider that Jiangsu Huaxin New MaterialLtd's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

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

There's an inherent assumption that a company should outperform the market for P/E ratios like Jiangsu Huaxin New MaterialLtd's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 16%. The last three years don't look nice either as the company has shrunk EPS by 9.5% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

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 Jiangsu Huaxin New MaterialLtd 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. 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 Jiangsu Huaxin New MaterialLtd's P/E?

Despite the recent share price weakness, Jiangsu Huaxin New MaterialLtd's P/E remains higher than most other companies. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Jiangsu Huaxin New MaterialLtd 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.

There are also other vital risk factors to consider and we've discovered 2 warning signs for Jiangsu Huaxin New MaterialLtd (1 can't be ignored!) that you should be aware of before investing here.

If these risks are making you reconsider your opinion on Jiangsu Huaxin New MaterialLtd, 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.