China Chengtong Development Group Limited (HKG:217) shareholders have had their patience rewarded with a 38% share price jump in the last month. Taking a wider view, although not as strong as the last month, the full year gain of 23% is also fairly reasonable.
Since its price has surged higher, China Chengtong Development Group's price-to-earnings (or "P/E") ratio of 12x might make it look like a 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. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
For instance, China Chengtong Development Group's receding earnings in recent times would have to be some food for thought. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.
Check out our latest analysis for China Chengtong Development Group
Does Growth Match The High P/E?
In order to justify its P/E ratio, China Chengtong Development Group would need to produce impressive growth in excess of the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 40%. As a result, earnings from three years ago have also fallen 66% 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 22% shows it's an unpleasant look.
In light of this, it's alarming that China Chengtong Development Group's 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
The large bounce in China Chengtong Development Group's shares has lifted the company's P/E to a fairly high level. 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.
We've established that China Chengtong Development Group currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, 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.
Plus, you should also learn about these 3 warning signs we've spotted with China Chengtong Development Group (including 1 which is significant).
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.