Do-Fluoride New Materials Co., Ltd. (SZSE:002407) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 33% over that time.
Following the firm bounce in price, Do-Fluoride New Materials' price-to-earnings (or "P/E") ratio of 37.7x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 30x and even P/E's below 18x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.
Do-Fluoride New Materials could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. 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?
The only time you'd be truly comfortable seeing a P/E as high as Do-Fluoride New Materials' is when the company's growth is on track to outshine the market.
Retrospectively, the last year delivered a frustrating 75% decrease to the company's bottom line. Even so, admirably EPS has lifted 765% in aggregate from three years ago, notwithstanding the last 12 months. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.
Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 41% per annum over the next three years. With the market only predicted to deliver 20% per year, the company is positioned for a stronger earnings result.
With this information, we can see why Do-Fluoride New Materials is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Key Takeaway
The large bounce in Do-Fluoride New Materials' 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.
As we suspected, our examination of Do-Fluoride New Materials' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
Having said that, be aware Do-Fluoride New Materials is showing 3 warning signs in our investment analysis, you should know about.
If these risks are making you reconsider your opinion on Do-Fluoride New Materials, explore our interactive list of high quality stocks to get an idea of what else is out there.
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