When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 8x, you may consider The Hong Kong and China Gas Company Limited (HKG:3) as a stock to avoid entirely with its 18.7x P/E ratio. 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.
Hong Kong and China Gas certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.
What Are Growth Metrics Telling Us About The High P/E?
Hong Kong and China Gas' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
Retrospectively, the last year delivered an exceptional 34% gain to the company's bottom line. Still, incredibly EPS has fallen 3.4% in total from three years ago, which is quite disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 5.3% per year over the next three years. That's shaping up to be materially lower than the 16% per annum growth forecast for the broader market.
In light of this, it's alarming that Hong Kong and China Gas' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Final Word
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 Hong Kong and China Gas currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Having said that, be aware Hong Kong and China Gas is showing 2 warning signs in our investment analysis, you should know about.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.