Hunan Valin Wire & Cable Co.,Ltd.'s (SZSE:001208) price-to-earnings (or "P/E") ratio of 52.4x might 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 31x and even P/E's below 19x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
For instance, Hunan Valin Wire & CableLtd's receding earnings in recent times would have to be some food for thought. 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.
Is There Enough Growth For Hunan Valin Wire & CableLtd?
In order to justify its P/E ratio, Hunan Valin Wire & CableLtd 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 23%. As a result, earnings from three years ago have also fallen 30% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
In contrast to the company, the rest of the market is expected to grow by 38% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
In light of this, it's alarming that Hunan Valin Wire & CableLtd'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 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.
Our examination of Hunan Valin Wire & CableLtd revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
And what about other risks? Every company has them, and we've spotted 1 warning sign for Hunan Valin Wire & CableLtd you should know about.
Of course, you might also be able to find a better stock than Hunan Valin Wire & CableLtd. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.