Harbin Air Conditioning Co.,Ltd. (SHSE:600202) shares have had a horrible month, losing 28% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 17% share price drop.
In spite of the heavy fall in price, Harbin Air ConditioningLtd's price-to-earnings (or "P/E") ratio of 69.9x 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 27x and even P/E's below 17x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
For example, consider that Harbin Air ConditioningLtd's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.
Does Growth Match The High P/E?
In order to justify its P/E ratio, Harbin Air ConditioningLtd would need to produce outstanding growth well in excess of the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 47%. This means it has also seen a slide in earnings over the longer-term as EPS is down 40% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
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 Harbin Air ConditioningLtd's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
The Key Takeaway
Harbin Air ConditioningLtd's shares may have retreated, but its P/E is still flying high. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Harbin Air ConditioningLtd currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
Having said that, be aware Harbin Air ConditioningLtd is showing 2 warning signs in our investment analysis, and 1 of those shouldn't be ignored.
Of course, you might also be able to find a better stock than Harbin Air ConditioningLtd. 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.