When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Tiangong International Company Limited (HKG:826) as a stock to potentially avoid with its 11.4x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

While the market has experienced earnings growth lately, Tiangong International's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Is There Enough Growth For Tiangong International?

Tiangong International's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 26%. This means it has also seen a slide in earnings over the longer-term as EPS is down 35% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the sole analyst covering the company suggest earnings should grow by 73% over the next year. Meanwhile, the rest of the market is forecast to only expand by 19%, which is noticeably less attractive.

In light of this, it's understandable that Tiangong International's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

As we suspected, our examination of Tiangong International's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Tiangong International with six simple checks will allow you to discover any risks that could be an issue.

If these risks are making you reconsider your opinion on Tiangong International, 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com