The Tongguan Gold Group Limited (HKG:340) share price has done very well over the last month, posting an excellent gain of 30%. Looking back a bit further, it's encouraging to see the stock is up 50% in the last year.
Following the firm bounce in price, Tongguan Gold Group may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 45.1x, since almost half of all companies in Hong Kong have P/E ratios under 9x and even P/E's lower than 5x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
For example, consider that Tongguan Gold Group'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.
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Tongguan Gold Group's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered a frustrating 6.2% decrease to the company's bottom line. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. 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 21% 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 Tongguan Gold Group'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 good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.
The Key Takeaway
The strong share price surge has got Tongguan Gold Group's P/E rushing to great heights as well. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
We've established that Tongguan Gold Group 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 settle on your opinion, we've discovered 2 warning signs for Tongguan Gold Group that you should be aware of.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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