Lenovo Group Limited's (HKG:992) price-to-earnings (or "P/E") ratio of 18.3x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 5x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
While the market has experienced earnings growth lately, Lenovo Group's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Lenovo Group's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered a frustrating 54% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 12% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Turning to the outlook, the next three years should generate growth of 28% each year as estimated by the analysts watching the company. With the market only predicted to deliver 16% per annum, the company is positioned for a stronger earnings result.
With this information, we can see why Lenovo Group is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
What We Can Learn From Lenovo Group's P/E?
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 Lenovo Group maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.
Before you settle on your opinion, we've discovered 3 warning signs for Lenovo Group that you should be aware of.
Of course, you might also be able to find a better stock than Lenovo Group. 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.