Changhua Holding Group Co., Ltd. (SHSE:605018) shareholders are no doubt pleased to see that the share price has bounced 29% in the last month, although it is still struggling to make up recently lost ground. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 15% in the last twelve months.
After such a large jump in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 31x, you may consider Changhua Holding Group as a stock to potentially avoid with its 42.7x 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 instance, Changhua Holding Group's receding earnings in recent times would have to be some food for thought. 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.
Is There Enough Growth For Changhua Holding Group?
The only time you'd be truly comfortable seeing a P/E as high as Changhua Holding Group's is when the company's growth is on track to outshine the market.
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 16%. As a result, earnings from three years ago have also fallen 56% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Comparing that to the market, which is predicted to deliver 40% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.
With this information, we find it concerning that Changhua Holding Group is trading at a P/E higher than the market. 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. 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 Bottom Line On Changhua Holding Group's P/E
The large bounce in Changhua Holding Group's shares has lifted the company's P/E to a fairly high level. 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.
Our examination of Changhua Holding Group 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
You should always think about risks. Case in point, we've spotted 2 warning signs for Changhua Holding Group you should be aware of, and 1 of them is concerning.
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.
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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.