More Unpleasant Surprises Could Be In Store For Dongguan Golden Sun Abrasives Co.,Ltd's (SZSE:300606) Shares After Tumbling 30%

Dongguan Golden Sun Abrasives Co.,Ltd (SZSE:300606) shareholders that were waiting for something to happen have been dealt a blow with a 30% share price drop in the last month. The recent drop has obliterated the annual return, with the share price now down 7.9% over that longer period.

In spite of the heavy fall in price, Dongguan Golden Sun AbrasivesLtd's price-to-earnings (or "P/E") ratio of 34.8x might still make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 30x and even P/E's below 18x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's exceedingly strong of late, Dongguan Golden Sun AbrasivesLtd 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.

Check out our latest analysis for Dongguan Golden Sun AbrasivesLtd

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Dongguan Golden Sun AbrasivesLtd will help you shine a light on its historical performance.

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 Dongguan Golden Sun AbrasivesLtd's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 215% last year. Still, incredibly EPS has fallen 16% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 38% shows it's an unpleasant look.

With this information, we find it concerning that Dongguan Golden Sun AbrasivesLtd 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 Final Word

Despite the recent share price weakness, Dongguan Golden Sun AbrasivesLtd's P/E remains higher than most other companies. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Dongguan Golden Sun AbrasivesLtd 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.

You should always think about risks. Case in point, we've spotted 2 warning signs for Dongguan Golden Sun AbrasivesLtd you should be aware of, and 1 of them doesn't sit too well with us.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.