It's not a stretch to say that China Foods Limited's (HKG:506) price-to-earnings (or "P/E") ratio of 7.8x right now seems quite "middle-of-the-road" compared to the market in Hong Kong, where the median P/E ratio is around 9x. 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 China Foods 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.
Check out our latest analysis for China Foods
Does Growth Match The P/E?
China Foods' P/E ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the market.
If we review the last year of earnings growth, the company posted a terrific increase of 26%. The strong recent performance means it was also able to grow EPS by 67% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 2.7% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 15% per year, which is noticeably more attractive.
With this information, we find it interesting that China Foods is trading at a fairly similar P/E to the market. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. 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 China Foods' P/E
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 China Foods currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
Don't forget that there may be other risks. For instance, we've identified 1 warning sign for China Foods that you should be aware of.
If these risks are making you reconsider your opinion on China Foods, 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.