It's not a stretch to say that Anhui Expressway Company Limited's (HKG:995) price-to-earnings (or "P/E") ratio of 7.2x right now seems quite "middle-of-the-road" compared to the market in Hong Kong, where the median P/E ratio is around 9x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.
With its earnings growth in positive territory compared to the declining earnings of most other companies, Anhui Expressway has been doing quite well of late. One possibility is that the P/E is moderate because investors think the company's earnings will be less resilient moving forward. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.
Check out our latest analysis for Anhui Expressway
Does Growth Match The P/E?
There's an inherent assumption that a company should be matching the market for P/E ratios like Anhui Expressway's to be considered reasonable.
If we review the last year of earnings growth, the company posted a worthy increase of 12%. Pleasingly, EPS has also lifted 121% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Shifting to the future, estimates from the only analyst covering the company suggest earnings should grow by 16% over the next year. With the market predicted to deliver 23% growth , the company is positioned for a weaker earnings result.
In light of this, it's curious that Anhui Expressway's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.
The Key Takeaway
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.
We've established that Anhui Expressway currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Anhui Expressway with six simple checks.
If you're unsure about the strength of Anhui Expressway's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.