New East New Materials Co., Ltd's (SHSE:603110) 27% Share Price Plunge Could Signal Some Risk

New East New Materials Co., Ltd (SHSE:603110) shareholders that were waiting for something to happen have been dealt a blow with a 27% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 46% in that time.

Even after such a large drop in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 31x, you may still consider New East New Materials as a stock to avoid entirely with its 51.5x 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 so lofty.

With earnings growth that's exceedingly strong of late, New East New Materials has been doing very well. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for New East New Materials

Although there are no analyst estimates available for New East New Materials, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Does Growth Match The High P/E?

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

If we review the last year of earnings growth, the company posted a terrific increase of 130%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 5.8% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 38% 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 New East New Materials is trading at a P/E higher than the market. 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 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.

The Key Takeaway

Even after such a strong price drop, New East New Materials' P/E still exceeds the rest of the market significantly. 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 New East New Materials 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.

You should always think about risks. Case in point, we've spotted 3 warning signs for New East New Materials you should be aware of, and 2 of them are a bit unpleasant.

You might be able to find a better investment than New East New Materials. 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.