China Leon Inspection Holding Limited (HKG:1586) shareholders would be excited to see that the share price has had a great month, posting a 38% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 40% in the last year.
Following the firm bounce in price, China Leon Inspection Holding's price-to-earnings (or "P/E") ratio of 13x 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. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
We'd have to say that with no tangible growth over the last year, China Leon Inspection Holding's earnings have been unimpressive. One possibility is that the P/E is high because investors think the benign earnings growth will improve to outperform the broader market in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.
Check out our latest analysis for China Leon Inspection Holding
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, China Leon Inspection Holding would need to produce impressive growth in excess of the market.
Taking a look back first, we see that there was hardly any earnings per share growth to speak of for the company over the past year. Still, the latest three year period has seen an excellent 35% overall rise in EPS, in spite of its uninspiring short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.
Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 22% shows it's noticeably less attractive on an annualised basis.
With this information, we find it concerning that China Leon Inspection Holding is trading at a P/E higher than the market. 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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.
The Final Word
China Leon Inspection Holding's P/E is getting right up there since its shares have risen strongly. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
Our examination of China Leon Inspection Holding 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. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. 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.
A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for China Leon Inspection Holding with six simple checks.
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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