Bairong Inc. (HKG:6608) shareholders would be excited to see that the share price has had a great month, posting a 25% gain and recovering from prior weakness. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.
After such a large jump in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Bairong as a stock to avoid entirely with its 15.6x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
While the market has experienced earnings growth lately, Bairong's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.
See our latest analysis for Bairong
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Bairong's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered a frustrating 18% decrease to the company's bottom line. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 30% per year over the next three years. With the market only predicted to deliver 12% per annum, the company is positioned for a stronger earnings result.
With this information, we can see why Bairong is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.
The Key Takeaway
Shares in Bairong have built up some good momentum lately, which has really inflated its P/E. 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 Bairong maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Bairong, and understanding should be part of your investment process.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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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.