Chongqing Yukaifa Co., Ltd (SZSE:000514) shares have had a really impressive month, gaining 37% after a shaky period beforehand. Notwithstanding the latest gain, the annual share price return of 9.8% isn't as impressive.

In spite of the firm bounce in price, there still wouldn't be many who think Chongqing Yukaifa's price-to-earnings (or "P/E") ratio of 35.2x is worth a mention when the median P/E in China is similar at about 33x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

For instance, Chongqing Yukaifa's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is moderate because investors think the company might still do enough to be in line with the broader market in the near future. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

Is There Some Growth For Chongqing Yukaifa?

There's an inherent assumption that a company should be matching the market for P/E ratios like Chongqing Yukaifa'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 36%. As a result, earnings from three years ago have also fallen 30% 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 38% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Chongqing Yukaifa is trading at a fairly similar P/E to the market. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. 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 the recent negative growth rates.

The Bottom Line On Chongqing Yukaifa's P/E

Chongqing Yukaifa appears to be back in favour with a solid price jump getting its P/E back in line with 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.

We've established that Chongqing Yukaifa currently trades on a higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Chongqing Yukaifa, and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Chongqing Yukaifa, 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.