Despite an already strong run, Guangdong New Grand Long Packing Co., Ltd. (SZSE:002836) shares have been powering on, with a gain of 34% in the last thirty days. Unfortunately, despite the strong performance over the last month, the full year gain of 6.2% isn't as attractive.
After such a large jump in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 33x, you may consider Guangdong New Grand Long Packing as a stock to potentially avoid with its 41.9x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.
For instance, Guangdong New Grand Long Packing'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Does Growth Match The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Guangdong New Grand Long Packing's to be considered reasonable.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 42%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 70% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.
This is in contrast to the rest of the market, which is expected to grow by 37% over the next year, materially higher than the company's recent medium-term annualised growth rates.
With this information, we find it concerning that Guangdong New Grand Long Packing 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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.
The Final Word
Guangdong New Grand Long Packing 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 Guangdong New Grand Long Packing currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, 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.
You always need to take note of risks, for example - Guangdong New Grand Long Packing has 2 warning signs we think 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.