There wouldn't be many who think Cheerwin Group Limited's (HKG:6601) price-to-earnings (or "P/E") ratio of 11.8x is worth a mention when the median P/E in Hong Kong is similar at about 10x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

Recent times have been advantageous for Cheerwin Group as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. 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?

There's an inherent assumption that a company should be matching the market for P/E ratios like Cheerwin Group's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 93% gain to the company's bottom line. As a result, it also grew EPS by 12% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 3.4% per annum as estimated by the dual analysts watching the company. That's shaping up to be materially lower than the 12% each year growth forecast for the broader market.

In light of this, it's curious that Cheerwin Group's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. 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

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Cheerwin Group's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. 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. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You should always think about risks. Case in point, we've spotted 1 warning sign for Cheerwin Group you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.