Shanghai Shentong Metro Co.,Ltd. (SHSE:600834) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 27% in that time.
Although its price has dipped substantially, Shanghai Shentong MetroLtd's price-to-earnings (or "P/E") ratio of 37.9x might still make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 25x and even P/E's below 15x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
Earnings have risen firmly for Shanghai Shentong MetroLtd recently, which is pleasing to see. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Shanghai Shentong MetroLtd's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered a decent 8.2% gain to the company's bottom line. Still, EPS has barely risen at all in aggregate from three years ago, which is not ideal. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's an unpleasant look.
In light of this, it's alarming that Shanghai Shentong MetroLtd's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.
The Final Word
A significant share price dive has done very little to deflate Shanghai Shentong MetroLtd's very lofty 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 Shanghai Shentong MetroLtd currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Shanghai Shentong MetroLtd with six simple checks on some of these key factors.
If you're unsure about the strength of Shanghai Shentong MetroLtd'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.