Canggang Railway Limited (HKG:2169) shareholders are no doubt pleased to see that the share price has bounced 29% in the last month, although it is still struggling to make up recently lost ground. Looking back a bit further, it's encouraging to see the stock is up 49% in the last year.
Following the firm bounce in price, Canggang Railway's price-to-earnings (or "P/E") ratio of 72.5x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 5x 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 so lofty.
As an illustration, earnings have deteriorated at Canggang Railway over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for Canggang Railway
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Canggang Railway's is when the company's growth is on track to outshine the market decidedly.
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%. As a result, earnings from three years ago have also fallen 25% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 21% shows it's an unpleasant look.
With this information, we find it concerning that Canggang Railway is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.
The Key Takeaway
The strong share price surge has got Canggang Railway's P/E rushing to great heights as well. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
We've established that Canggang Railway currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
And what about other risks? Every company has them, and we've spotted 3 warning signs for Canggang Railway you should know about.
If these risks are making you reconsider your opinion on Canggang Railway, 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.