China Telecom Corporation Limited's (HKG:728) price-to-earnings (or "P/E") ratio of 12.7x might make it look like a sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 5x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

China Telecom certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

Does Growth Match The High P/E?

In order to justify its P/E ratio, China Telecom would need to produce impressive growth in excess of the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 9.5% last year. The latest three year period has also seen a 27% overall rise in EPS, aided somewhat by its short-term performance. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 8.2% per year over the next three years. That's shaping up to be materially lower than the 16% per year growth forecast for the broader market.

In light of this, it's alarming that China Telecom's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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.

The Bottom Line On China Telecom's P/E

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 China Telecom 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. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You always need to take note of risks, for example - China Telecom has 1 warning sign we think you should be aware of.

If these risks are making you reconsider your opinion on China Telecom, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

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