With a price-to-earnings (or "P/E") ratio of 24.9x Semiconductor Manufacturing International Corporation (HKG:981) may be sending very bearish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios under 9x and even P/E's lower than 5x are not unusual. 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.

Semiconductor Manufacturing International could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Growth Metrics Telling Us About The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Semiconductor Manufacturing International'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 54%. This means it has also seen a slide in earnings over the longer-term as EPS is down 18% 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.

Looking ahead now, EPS is anticipated to climb by 9.0% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 16% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's alarming that Semiconductor Manufacturing International's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

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 Semiconductor Manufacturing International's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Semiconductor Manufacturing International (at least 1 which is a bit unpleasant), and understanding these should be part of your investment process.

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.

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