Wuxi Best Precision Machinery Co., Ltd. (SZSE:300580) shareholders are no doubt pleased to see that the share price has bounced 27% in the last month, although it is still struggling to make up recently lost ground. Looking back a bit further, it's encouraging to see the stock is up 69% in the last year.
After such a large jump in price, Wuxi Best Precision Machinery may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 33.6x, 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, Wuxi Best Precision Machinery 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. If not, then existing shareholders might be a little nervous about the viability of the share price.
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Wuxi Best Precision Machinery's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 44% last year. The strong recent performance means it was also able to grow EPS by 44% 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 three analysts covering the company suggest earnings should grow by 13% over the next year. That's shaping up to be materially lower than the 41% growth forecast for the broader market.
With this information, we find it concerning that Wuxi Best Precision Machinery is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
What We Can Learn From Wuxi Best Precision Machinery's P/E?
Wuxi Best Precision Machinery shares have received a push in the right direction, but its P/E is elevated too. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
We've established that Wuxi Best Precision Machinery currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Plus, you should also learn about these 3 warning signs we've spotted with Wuxi Best Precision Machinery.
Of course, you might also be able to find a better stock than Wuxi Best Precision Machinery. 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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