Risks Still Elevated At These Prices As Linewell Software Co., Ltd. (SHSE:603636) Shares Dive 29%

Linewell Software Co., Ltd. (SHSE:603636) shareholders won't be pleased to see that the share price has had a very rough month, dropping 29% and undoing the prior period's positive performance. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 46% in that time.

In spite of the heavy fall in price, Linewell Software's price-to-earnings (or "P/E") ratio of 48.3x 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 29x and even P/E's below 18x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For example, consider that Linewell Software's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Linewell Software

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 Linewell Software's earnings, revenue and cash flow.

How Is Linewell Software's Growth Trending?

In order to justify its P/E ratio, Linewell Software would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 4.6%. This means it has also seen a slide in earnings over the longer-term as EPS is down 19% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 35% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Linewell Software'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 Key Takeaway

A significant share price dive has done very little to deflate Linewell Software's very lofty P/E. 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.

We've established that Linewell Software currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

And what about other risks? Every company has them, and we've spotted 4 warning signs for Linewell Software (of which 2 don't sit too well with us!) you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.