Chengdu Galaxy Magnets Co.,Ltd. (SZSE:300127) shares have had a really impressive month, gaining 27% after a shaky period beforehand. Looking further back, the 13% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Following the firm bounce in price, Chengdu Galaxy MagnetsLtd may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 38x, since almost half of all companies in China have P/E ratios under 30x and even P/E's lower than 18x 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.

Chengdu Galaxy MagnetsLtd hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. 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.

How Is Chengdu Galaxy MagnetsLtd's Growth Trending?

In order to justify its P/E ratio, Chengdu Galaxy MagnetsLtd would need to produce impressive growth in excess of the market.

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 5.7%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 8.3% overall rise in EPS. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.

Turning to the outlook, the next three years should generate growth of 14% per annum as estimated by the sole analyst watching the company. Meanwhile, the rest of the market is forecast to expand by 20% per annum, which is noticeably more attractive.

With this information, we find it concerning that Chengdu Galaxy MagnetsLtd is trading at a P/E higher than the market. 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

Chengdu Galaxy MagnetsLtd shares have received a push in the right direction, but its P/E is elevated too. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Chengdu Galaxy MagnetsLtd 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. Unless these 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 1 warning sign for Chengdu Galaxy MagnetsLtd you should know about.

If these risks are making you reconsider your opinion on Chengdu Galaxy MagnetsLtd, explore our interactive list of high quality stocks to get an idea of what else is out there.

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