With a price-to-earnings (or "P/E") ratio of 48.3x Novogene Co., Ltd. (SHSE:688315) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 34x and even P/E's lower than 20x 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 as high as it is.
With earnings that are retreating more than the market's of late, Novogene has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.
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Is There Enough Growth For Novogene?
The only time you'd be truly comfortable seeing a P/E as high as Novogene's is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered a frustrating 8.5% decrease to the company's bottom line. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Turning to the outlook, the next year should generate growth of 35% as estimated by the three analysts watching the company. With the market predicted to deliver 44% growth , the company is positioned for a weaker earnings result.
With this information, we find it concerning that Novogene is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Bottom Line On Novogene's 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 Novogene currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
It is also worth noting that we have found 1 warning sign for Novogene that you need to take into consideration.
You might be able to find a better investment than Novogene. 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).
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