When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Success Dragon International Holdings Limited (HKG:1182) as a stock to potentially avoid with its 13x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
Earnings have risen firmly for Success Dragon International Holdings recently, which is pleasing to see. One possibility is that the P/E is high because investors think this respectable earnings growth will be enough 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 Success Dragon International Holdings
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should outperform the market for P/E ratios like Success Dragon International Holdings' to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 15% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Comparing that to the market, which is predicted to deliver 23% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.
With this information, we find it concerning that Success Dragon International Holdings is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 Bottom Line On Success Dragon International Holdings' P/E
Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
Our examination of Success Dragon International 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.
You should always think about risks. Case in point, we've spotted 3 warning signs for Success Dragon International Holdings you should be aware of, and 2 of them don't sit too well with us.
Of course, you might also be able to find a better stock than Success Dragon International Holdings. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.