With a median price-to-earnings (or "P/E") ratio of close to 10x in Hong Kong, you could be forgiven for feeling indifferent about CGN Power Co., Ltd.'s (HKG:1816) P/E ratio of 11.9x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.
Recent earnings growth for CGN Power has been in line with the market. It seems that many are expecting the mediocre earnings performance to persist, which has held the P/E back. If you like the company, you'd be hoping this can at least be maintained so that you could pick up some stock while it's not quite in favour.
Is There Some Growth For CGN Power?
In order to justify its P/E ratio, CGN Power would need to produce growth that's similar to the market.
If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. Fortunately, a few good years before that means that it was still able to grow EPS by 8.8% in total over the last three years. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Turning to the outlook, the next three years should generate growth of 7.9% per annum as estimated by the eleven analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 12% per year, which is noticeably more attractive.
With this information, we find it interesting that CGN Power is trading at a fairly similar P/E to the market. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.
The Final Word
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 CGN Power currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
And what about other risks? Every company has them, and we've spotted 1 warning sign for CGN Power you should know about.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.