There's Reason For Concern Over Edan Instruments, Inc.'s (SZSE:300206) Massive 28% Price Jump

Despite an already strong run, Edan Instruments, Inc. (SZSE:300206) shares have been powering on, with a gain of 28% in the last thirty days. Notwithstanding the latest gain, the annual share price return of 3.3% isn't as impressive.

After such a large jump in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Edan Instruments as a stock to avoid entirely with its 47.2x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, Edan Instruments' receding earnings in recent times would have to be some food for thought. 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.

Check out our latest analysis for Edan Instruments

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Edan Instruments' earnings, revenue and cash flow.

How Is Edan Instruments' Growth Trending?

Edan Instruments' 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 52%. This means it has also seen a slide in earnings over the longer-term as EPS is down 62% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 36% 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 Edan Instruments' 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 Final Word

Edan Instruments' P/E is flying high just like its stock has during the last month. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Edan Instruments 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.

Plus, you should also learn about these 4 warning signs we've spotted with Edan Instruments (including 1 which shouldn't be ignored).

If these risks are making you reconsider your opinion on Edan Instruments, 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.