It's not a stretch to say that CGN Power Co., Ltd.'s (HKG:1816) price-to-earnings (or "P/E") ratio of 11.6x right now seems quite "middle-of-the-road" compared to the market in Hong Kong, where the median P/E ratio is around 10x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
Recent earnings growth for CGN Power has been in line with the market. It seems that many are expecting the mediocre earnings performance to persist, which has held the P/E back. If you like the company, you'd be hoping this can at least be maintained so that you could pick up some stock while it's not quite in favour.
Check out our latest analysis for CGN Power
What Are Growth Metrics Telling Us About The P/E?
In order to justify its P/E ratio, CGN Power would need to produce growth that's similar to 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. Regardless, EPS has managed to lift by a handy 8.8% in aggregate from three years ago, thanks to the earlier period of growth. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.
Shifting to the future, estimates from the ten analysts covering the company suggest earnings should grow by 7.8% each year over the next three years. That's shaping up to be materially lower than the 12% per annum growth forecast for the broader market.
In light of this, it's curious that CGN Power's P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Key Takeaway
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.
We've established that CGN Power currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
We don't want to rain on the parade too much, but we did also find 1 warning sign for CGN Power that you need to be mindful of.
If these risks are making you reconsider your opinion on CGN Power, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.