There wouldn't be many who think Hainan Strait Shipping Co.,Ltd.'s (SZSE:002320) price-to-earnings (or "P/E") ratio of 26.6x is worth a mention when the median P/E in China is similar at about 27x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

With earnings growth that's superior to most other companies of late, Hainan Strait ShippingLtd has been doing relatively well. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

What Are Growth Metrics Telling Us About The P/E?

The only time you'd be comfortable seeing a P/E like Hainan Strait ShippingLtd's is when the company's growth is tracking the market closely.

Taking a look back first, we see that the company grew earnings per share by an impressive 109% last year. The strong recent performance means it was also able to grow EPS by 54% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 18% per annum as estimated by the one analyst watching the company. Meanwhile, the rest of the market is forecast to expand by 24% each year, which is noticeably more attractive.

With this information, we find it interesting that Hainan Strait ShippingLtd 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 Key Takeaway

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Hainan Strait ShippingLtd currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Hainan Strait ShippingLtd, and understanding should be part of your investment process.

If these risks are making you reconsider your opinion on Hainan Strait ShippingLtd, 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com