It's not a stretch to say that Shanghai Chinafortune Co., Ltd.'s (SHSE:600621) price-to-earnings (or "P/E") ratio of 28.5x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 32x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
Shanghai Chinafortune certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably moderate because investors think this strong earnings growth might not be enough to outperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.
Does Growth Match The P/E?
There's an inherent assumption that a company should be matching the market for P/E ratios like Shanghai Chinafortune's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 105% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 20% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Comparing that to the market, which is predicted to deliver 37% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.
In light of this, it's somewhat alarming that Shanghai Chinafortune's P/E sits in line with the majority of other companies. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh on the share price eventually.
The Bottom Line On Shanghai Chinafortune's P/E
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.
We've established that Shanghai Chinafortune currently trades on a higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
It is also worth noting that we have found 1 warning sign for Shanghai Chinafortune that you need to take into consideration.
Of course, you might also be able to find a better stock than Shanghai Chinafortune. 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.