The Jiangxi Selon Industrial Co., Ltd. (SZSE:002748) share price has fared very poorly over the last month, falling by a substantial 35%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 41% in that time.
In spite of the heavy fall in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 24x, you may still consider Jiangxi Selon Industrial as a stock to potentially avoid with its 26.9x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
For example, consider that Jiangxi Selon Industrial's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Jiangxi Selon Industrial's to be considered reasonable.
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 74%. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Comparing that to the market, which is predicted to deliver 42% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.
In light of this, it's alarming that Jiangxi Selon Industrial's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.
The Final Word
Despite the recent share price weakness, Jiangxi Selon Industrial's P/E remains higher than most other companies. 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 Jiangxi Selon Industrial 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. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Before you take the next step, you should know about the 2 warning signs for Jiangxi Selon Industrial (1 is a bit unpleasant!) that we have uncovered.
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.