With a price-to-earnings (or "P/E") ratio of 74.6x Eastern Communications Co.,Ltd. (SHSE:600776) may be sending very 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 so lofty.
With earnings growth that's exceedingly strong of late, Eastern CommunicationsLtd has been doing very well. 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.
Check out our latest analysis for Eastern CommunicationsLtd
Is There Enough Growth For Eastern CommunicationsLtd?
In order to justify its P/E ratio, Eastern CommunicationsLtd would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered an exceptional 52% gain to the company's bottom line. The latest three year period has also seen an excellent 48% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.
Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 44% shows it's noticeably less attractive on an annualised basis.
With this information, we find it concerning that Eastern CommunicationsLtd 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
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Eastern CommunicationsLtd currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Eastern CommunicationsLtd with six simple checks.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).
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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.