The China XD Electric Co., Ltd (SHSE:601179) share price has done very well over the last month, posting an excellent gain of 38%. Looking back a bit further, it's encouraging to see the stock is up 38% in the last year.
Following the firm bounce in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider China XD Electric as a stock to potentially avoid with its 43.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
With earnings growth that's superior to most other companies of late, China XD Electric has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Does Growth Match The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like China XD Electric's to be considered reasonable.
If we review the last year of earnings growth, the company posted a terrific increase of 43%. The latest three year period has also seen an excellent 263% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Looking ahead now, EPS is anticipated to climb by 22% each year during the coming three years according to the three analysts following the company. That's shaping up to be similar to the 21% per year growth forecast for the broader market.
With this information, we find it interesting that China XD Electric is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
The Bottom Line On China XD Electric's P/E
The large bounce in China XD Electric's shares has lifted the company's P/E to a fairly high level. 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.
Our examination of China XD Electric's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
You should always think about risks. Case in point, we've spotted 1 warning sign for China XD Electric you should be aware of.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).
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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.