The Hunan Sokan New Materials Co., Ltd. (SHSE:688157) share price has fared very poorly over the last month, falling by a substantial 28%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 44% in that time.
Although its price has dipped substantially, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 31x, you may still consider Hunan Sokan New Materials as a stock to avoid entirely with its 60.2x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
With earnings that are retreating more than the market's of late, Hunan Sokan New Materials has been very sluggish. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for Hunan Sokan New Materials
Does Growth Match The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Hunan Sokan New Materials' to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 21%. As a result, earnings from three years ago have also fallen 37% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Turning to the outlook, the next year should generate growth of 70% as estimated by the four analysts watching the company. That's shaping up to be materially higher than the 42% growth forecast for the broader market.
In light of this, it's understandable that Hunan Sokan New Materials' 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.
What We Can Learn From Hunan Sokan New Materials' P/E?
Hunan Sokan New Materials' shares may have retreated, but its P/E is still flying high. 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 Hunan Sokan New Materials' 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.
Before you settle on your opinion, we've discovered 1 warning sign for Hunan Sokan New Materials that you should be aware of.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).
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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.