Shanghai Hi-Tech Control System Co., Ltd's (SZSE:002184) price-to-earnings (or "P/E") ratio of 37.3x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 29x and even P/E's below 18x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Shanghai Hi-Tech Control System could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.
Does Growth Match The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Shanghai Hi-Tech Control System's to be considered reasonable.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 43%. As a result, earnings from three years ago have also fallen 41% 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 266% as estimated by the sole analyst watching the company. That's shaping up to be materially higher than the 38% growth forecast for the broader market.
In light of this, it's understandable that Shanghai Hi-Tech Control System's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
What We Can Learn From Shanghai Hi-Tech Control System'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 Hi-Tech Control System maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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.
You should always think about risks. Case in point, we've spotted 2 warning signs for Shanghai Hi-Tech Control System you should be aware of.
If you're unsure about the strength of Shanghai Hi-Tech Control System'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.