With a median price-to-earnings (or "P/E") ratio of close to 9x in Hong Kong, you could be forgiven for feeling indifferent about Hengan International Group Company Limited's (HKG:1044) P/E ratio of 9.4x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.
With earnings growth that's superior to most other companies of late, Hengan International Group has been doing relatively well. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.
What Are Growth Metrics Telling Us About The P/E?
The only time you'd be comfortable seeing a P/E like Hengan International Group's is when the company's growth is tracking the market closely.
If we review the last year of earnings growth, the company posted a terrific increase of 46%. Still, incredibly EPS has fallen 38% in total from three years ago, which is quite disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 6.6% each year over the next three years. That's shaping up to be materially lower than the 15% per annum growth forecast for the broader market.
With this information, we find it interesting that Hengan International Group is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.
The Final Word
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.
We've established that Hengan International Group currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Having said that, be aware Hengan International Group is showing 1 warning sign in our investment analysis, you should know about.
If these risks are making you reconsider your opinion on Hengan International Group, explore our interactive list of high quality stocks to get an idea of what else is out there.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.