DongHua Testing Technology Co. , Ltd. (SZSE:300354) shares have had a really impressive month, gaining 26% after a shaky period beforehand. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 5.2% in the last twelve months.
Since its price has surged higher, DongHua Testing Technology may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 43.9x, 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 high for a reason and it requires further investigation to determine if it's justified.
With its earnings growth in positive territory compared to the declining earnings of most other companies, DongHua Testing Technology has been doing quite well of late. It seems that many are expecting the company to continue defying the broader market adversity, 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 high as DongHua Testing Technology's is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered an exceptional 50% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 339% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.
Shifting to the future, estimates from the two analysts covering the company suggest earnings should grow by 80% over the next year. Meanwhile, the rest of the market is forecast to only expand by 41%, which is noticeably less attractive.
In light of this, it's understandable that DongHua Testing Technology's 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.
The Key Takeaway
DongHua Testing Technology shares have received a push in the right direction, but its P/E is elevated too. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that DongHua Testing Technology maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.
Having said that, be aware DongHua Testing Technology is showing 2 warning signs in our investment analysis, you should know about.
Of course, you might also be able to find a better stock than DongHua Testing Technology. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.