The China Innovation Investment Limited (HKG:1217) share price has done very well over the last month, posting an excellent gain of 50%. Looking back a bit further, it's encouraging to see the stock is up 50% in the last year.
Since its price has surged higher, China Innovation Investment may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 60.7x, since almost half of all companies in Hong Kong have P/E ratios under 9x and even P/E's lower than 5x are not unusual. 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, China Innovation Investment's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as China Innovation Investment's is when the company's growth is on track to outshine the market decidedly.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 70%. This means it has also seen a slide in earnings over the longer-term as EPS is down 84% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 22% shows it's an unpleasant look.
In light of this, it's alarming that China Innovation Investment's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.
What We Can Learn From China Innovation Investment's P/E?
China Innovation Investment's P/E is flying high just like its stock has during the last month. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
Our examination of China Innovation Investment 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.
Before you settle on your opinion, we've discovered 4 warning signs for China Innovation Investment that you should be aware of.
If these risks are making you reconsider your opinion on China Innovation Investment, 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.