Guoguang Electric Co.,Ltd.Chengdu (SHSE:688776) shares have had a really impressive month, gaining 37% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 38% in the last twelve months.
Since its price has surged higher, Guoguang ElectricLtd.Chengdu may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 60.9x, since almost half of all companies in China have P/E ratios under 33x and even P/E's lower than 20x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
For instance, Guoguang ElectricLtd.Chengdu'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.
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Guoguang ElectricLtd.Chengdu would need to produce outstanding growth well in excess of the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 9.6%. As a result, earnings from three years ago have also fallen 45% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
In contrast to the company, the rest of the market is expected to grow by 36% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
In light of this, it's alarming that Guoguang ElectricLtd.Chengdu'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. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
The Key Takeaway
The strong share price surge has got Guoguang ElectricLtd.Chengdu's P/E rushing to great heights as well. 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 Guoguang ElectricLtd.Chengdu currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
And what about other risks? Every company has them, and we've spotted 2 warning signs for Guoguang ElectricLtd.Chengdu you should know about.
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.