When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 27x, you may consider Zhejiang Zomax Transmission Co., Ltd. (SHSE:603767) as a stock to avoid entirely with its 74.9x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
We'd have to say that with no tangible growth over the last year, Zhejiang Zomax Transmission's earnings have been unimpressive. It might be that many are expecting an improvement to the uninspiring earnings performance over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be a little nervous about the viability of the share price.
Is There Enough Growth For Zhejiang Zomax Transmission?
The only time you'd be truly comfortable seeing a P/E as steep as Zhejiang Zomax Transmission's is when the company's growth is on track to outshine the market decidedly.
Taking a look back first, we see that there was hardly any earnings per share growth to speak of for the company over the past year. Whilst it's an improvement, it wasn't enough to get the company out of the hole it was in, with earnings down 13% overall from three years ago. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
In contrast to the company, the rest of the market is expected to grow by 41% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
In light of this, it's alarming that Zhejiang Zomax Transmission's P/E sits above the majority of other companies. 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 very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
What We Can Learn From Zhejiang Zomax Transmission's P/E?
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
Our examination of Zhejiang Zomax Transmission revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. 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.
You should always think about risks. Case in point, we've spotted 3 warning signs for Zhejiang Zomax Transmission you should be aware of, and 2 of them shouldn't be ignored.
If you're unsure about the strength of Zhejiang Zomax Transmission'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.