With a price-to-earnings (or "P/E") ratio of 43.1x Perfect World Co., Ltd. (SZSE:002624) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 34x and even P/E's lower than 20x 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 as high as it is.
Perfect World has been struggling lately as its earnings have declined faster than most other companies. It might be that many expect the dismal 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.
View our latest analysis for Perfect World
Does Growth Match The High P/E?
Perfect World's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 46%. This means it has also seen a slide in earnings over the longer-term as EPS is down 70% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Turning to the outlook, the next year should generate growth of 122% as estimated by the analysts watching the company. That's shaping up to be materially higher than the 44% growth forecast for the broader market.
In light of this, it's understandable that Perfect World's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Bottom Line On Perfect World's P/E
We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
As we suspected, our examination of Perfect World's 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.
Plus, you should also learn about these 3 warning signs we've spotted with Perfect World (including 1 which shouldn't be ignored).
Of course, you might also be able to find a better stock than Perfect World. 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.