When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider CGN Power Co., Ltd. (HKG:1816) as a stock to potentially avoid with its 13.5x 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.
Recent earnings growth for CGN Power has been in line with the market. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Check out our latest analysis for CGN Power
How Is CGN Power's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as high as CGN Power's is when the company's growth is on track to outshine the market.
If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. The longer-term trend has been no better as the company has no earnings growth to show for over the last three years either. Accordingly, shareholders probably wouldn't have been satisfied with the complete absence of medium-term growth.
Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 6.2% each year over the next three years. That's shaping up to be materially lower than the 16% per year growth forecast for the broader market.
With this information, we find it concerning that CGN Power is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Key Takeaway
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
Our examination of CGN Power's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near 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 high P/E lower. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Having said that, be aware CGN Power is showing 2 warning signs in our investment analysis, and 1 of those shouldn't be ignored.
If these risks are making you reconsider your opinion on CGN Power, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.