With a price-to-earnings (or "P/E") ratio of 17.2x Geely Automobile Holdings Limited (HKG:175) may be sending very bearish signals at the moment, given that 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.

There hasn't been much to differentiate Geely Automobile Holdings' and the market's earnings growth lately. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.

How Is Geely Automobile Holdings' Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Geely Automobile Holdings' is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. This isn't what shareholders were looking for as it means they've been left with a 9.1% decline in EPS over the last three years in total. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 29% per annum as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 15% per annum, which is noticeably less attractive.

In light of this, it's understandable that Geely Automobile Holdings' P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Geely Automobile Holdings' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Geely Automobile Holdings with six simple checks will allow you to discover any risks that could be an issue.

If these risks are making you reconsider your opinion on Geely Automobile Holdings, 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.