Shenzhen Zhongheng Huafa Co., Ltd. (SZSE:200020) shares have had a really impressive month, gaining 26% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 12% in the last twelve months.
Since its price has surged higher, Shenzhen Zhongheng Huafa may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 46.1x, since almost half of all companies in China have P/E ratios under 35x and even P/E's lower than 20x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's exceedingly strong of late, Shenzhen Zhongheng Huafa 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. If not, then existing shareholders might be a little nervous about the viability of the share price.
See our latest analysis for Shenzhen Zhongheng Huafa
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Shenzhen Zhongheng Huafa's to be considered reasonable.
Retrospectively, the last year delivered an exceptional 86% gain to the company's bottom line. The latest three year period has also seen an excellent 102% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 44% shows it's noticeably less attractive on an annualised basis.
In light of this, it's alarming that Shenzhen Zhongheng Huafa'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.
The Key Takeaway
Shenzhen Zhongheng Huafa 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 Shenzhen Zhongheng Huafa 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.
Plus, you should also learn about this 1 warning sign we've spotted with Shenzhen Zhongheng Huafa.
If you're unsure about the strength of Shenzhen Zhongheng Huafa's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.