Hubei Hongyuan Pharmaceutical Technology Co., Ltd. (SZSE:301246) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. To make matters worse, the recent drop has wiped out a year's worth of gains with the share price now back where it started a year ago.

In spite of the heavy fall in price, Hubei Hongyuan Pharmaceutical Technology's price-to-earnings (or "P/E") ratio of 48.5x 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.

For example, consider that Hubei Hongyuan Pharmaceutical Technology'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.

Is There Enough Growth For Hubei Hongyuan Pharmaceutical Technology?

Hubei Hongyuan Pharmaceutical Technology's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 72%. As a result, earnings from three years ago have also fallen 38% overall. 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 41% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Hubei Hongyuan Pharmaceutical Technology'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. 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 Final Word

A significant share price dive has done very little to deflate Hubei Hongyuan Pharmaceutical Technology's very lofty P/E. 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.

We've established that Hubei Hongyuan Pharmaceutical Technology currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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.

It is also worth noting that we have found 2 warning signs for Hubei Hongyuan Pharmaceutical Technology that you need to take into consideration.

If you're unsure about the strength of Hubei Hongyuan Pharmaceutical 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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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.