ChengDu Hi-Tech Development Co., Ltd. (SZSE:000628) shareholders would be excited to see that the share price has had a great month, posting a 34% gain and recovering from prior weakness. The annual gain comes to 203% following the latest surge, making investors sit up and take notice.
Following the firm bounce in price, ChengDu Hi-Tech Development may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 52.6x, since almost half of all companies in China have P/E ratios under 29x and even P/E's lower than 18x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's exceedingly strong of late, ChengDu Hi-Tech Development has been doing very well. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Want the full picture on earnings, revenue and cash flow for the company? Then our free report on ChengDu Hi-Tech Development will help you shine a light on its historical performance.
Is There Enough Growth For ChengDu Hi-Tech Development?
The only time you'd be truly comfortable seeing a P/E as steep as ChengDu Hi-Tech Development's is when the company's growth is on track to outshine the market decidedly.
If we review the last year of earnings growth, the company posted a terrific increase of 48%. EPS has also lifted 21% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.
Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's noticeably less attractive on an annualised basis.
In light of this, it's alarming that ChengDu Hi-Tech Development's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.
What We Can Learn From ChengDu Hi-Tech Development's P/E?
ChengDu Hi-Tech Development's P/E is flying high just like its stock has during the last month. 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 Hi-Tech Development currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
You should always think about risks. Case in point, we've spotted 3 warning signs for ChengDu Hi-Tech Development you should be aware of, and 2 of them make us uncomfortable.
You might be able to find a better investment than ChengDu Hi-Tech Development. 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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