With a median price-to-earnings (or "P/E") ratio of close to 9x in Hong Kong, you could be forgiven for feeling indifferent about China Mengniu Dairy Company Limited's (HKG:2319) P/E ratio of 9.6x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.
While the market has experienced earnings growth lately, China Mengniu Dairy's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to strengthen positively, which has kept the P/E from falling. You'd really hope so, otherwise you're paying a relatively elevated price for a company with this sort of growth profile.
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What Are Growth Metrics Telling Us About The P/E?
There's an inherent assumption that a company should be matching the market for P/E ratios like China Mengniu Dairy's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 9.1%. Still, the latest three year period has seen an excellent 36% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 11% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 15% per year, which is noticeably more attractive.
With this information, we find it interesting that China Mengniu Dairy 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.
What We Can Learn From China Mengniu Dairy's P/E?
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.
Our examination of China Mengniu Dairy's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Don't forget that there may be other risks. For instance, we've identified 2 warning signs for China Mengniu Dairy that you should be aware of.
If you're unsure about the strength of China Mengniu Dairy's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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