With a price-to-earnings (or "P/E") ratio of 34.9x Wangfujing Group Co., Ltd. (SHSE:600859) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 30x and even P/E's lower than 19x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Wangfujing Group hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.
Does Growth Match The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Wangfujing Group'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 58%. This means it has also seen a slide in earnings over the longer-term as EPS is down 6.0% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 145% during the coming year according to the seven analysts following the company. That's shaping up to be materially higher than the 36% growth forecast for the broader market.
In light of this, it's understandable that Wangfujing Group's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Key Takeaway
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 Wangfujing Group maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. 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.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Wangfujing Group, and understanding them should be part of your investment process.
If these risks are making you reconsider your opinion on Wangfujing Group, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.