It's not a stretch to say that Huaming Power Equipment Co.,Ltd's (SZSE:002270) price-to-earnings (or "P/E") ratio of 35x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 33x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.
Recent times have been advantageous for Huaming Power EquipmentLtd as its earnings have been rising faster than most other companies. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.
What Are Growth Metrics Telling Us About The P/E?
In order to justify its P/E ratio, Huaming Power EquipmentLtd would need to produce growth that's similar to the market.
If we review the last year of earnings growth, the company posted a terrific increase of 45%. The strong recent performance means it was also able to grow EPS by 59% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 22% per annum during the coming three years according to the ten analysts following the company. That's shaping up to be materially lower than the 26% per annum growth forecast for the broader market.
With this information, we find it interesting that Huaming Power EquipmentLtd 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. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Bottom Line On Huaming Power EquipmentLtd's P/E
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.
Our examination of Huaming Power EquipmentLtd's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
And what about other risks? Every company has them, and we've spotted 1 warning sign for Huaming Power EquipmentLtd you should know about.
You might be able to find a better investment than Huaming Power EquipmentLtd. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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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.