Shenzhen Kaifa Technology Co., Ltd. (SZSE:000021) shareholders would be excited to see that the share price has had a great month, posting a 33% gain and recovering from prior weakness. Looking further back, the 14% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.
Since its price has surged higher, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 32x, you may consider Shenzhen Kaifa Technology as a stock to potentially avoid with its 38.6x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Shenzhen Kaifa Technology certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.
Does Growth Match The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Shenzhen Kaifa Technology's to be considered reasonable.
If we review the last year of earnings growth, the company posted a terrific increase of 42%. Still, incredibly EPS has fallen 28% in total from three years ago, which is quite disappointing. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
In contrast to the company, the rest of the market is expected to grow by 37% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
With this information, we find it concerning that Shenzhen Kaifa Technology is trading at a P/E higher than the market. 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.
The Bottom Line On Shenzhen Kaifa Technology's P/E
Shenzhen Kaifa Technology shares have received a push in the right direction, but its P/E is elevated too. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that Shenzhen Kaifa Technology 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. 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.
And what about other risks? Every company has them, and we've spotted 1 warning sign for Shenzhen Kaifa Technology you should know about.
Of course, you might also be able to find a better stock than Shenzhen Kaifa Technology. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.
