With a price-to-earnings (or "P/E") ratio of 15.2x Jia Yao Holdings Limited (HKG:1626) may be sending very bearish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios under 8x and even P/E's lower than 5x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Jia Yao Holdings certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
View our latest analysis for Jia Yao Holdings
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Jia Yao Holdings' to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 232% last year. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Comparing that to the market, which is predicted to deliver 22% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.
In light of this, it's alarming that Jia Yao Holdings' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Final Word
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 Jia Yao Holdings revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. 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.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Jia Yao Holdings with six simple checks on some of these key factors.
You might be able to find a better investment than Jia Yao Holdings. 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.