Foshan Haitian Flavouring and Food Company Ltd.'s (SHSE:603288) price-to-earnings (or "P/E") ratio of 35x 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 19x 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.
Foshan Haitian Flavouring and Food could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. 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 Foshan Haitian Flavouring and Food'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 11%. This means it has also seen a slide in earnings over the longer-term as EPS is down 4.2% 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 9.8% each year during the coming three years according to the analysts following the company. With the market predicted to deliver 20% growth each year, the company is positioned for a weaker earnings result.
In light of this, it's alarming that Foshan Haitian Flavouring and Food's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Final Word
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that Foshan Haitian Flavouring and Food currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Foshan Haitian Flavouring and Food that you should be aware of.
Of course, you might also be able to find a better stock than Foshan Haitian Flavouring and Food. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.