With a price-to-earnings (or "P/E") ratio of 21.6x Chinasoft International Limited (HKG:354) may be sending very bearish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios under 8x and even P/E's lower than 4x 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.
Chinasoft International has been struggling lately as its earnings have declined faster than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.
View our latest analysis for Chinasoft International
Is There Enough Growth For Chinasoft International?
In order to justify its P/E ratio, Chinasoft International would need to produce outstanding growth well in excess of the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 55%. This means it has also seen a slide in earnings over the longer-term as EPS is down 36% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 41% per annum over the next three years. That's shaping up to be materially higher than the 15% each year growth forecast for the broader market.
In light of this, it's understandable that Chinasoft International'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.
What We Can Learn From Chinasoft International's P/E?
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
As we suspected, our examination of Chinasoft International's analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. 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.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Chinasoft International, and understanding should be part of your investment process.
You might be able to find a better investment than Chinasoft International. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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