The Solomon Systech (International) Limited (HKG:2878) share price has softened a substantial 28% over the previous 30 days, handing back much of the gains the stock has made lately. Looking at the bigger picture, even after this poor month the stock is up 68% in the last year.
Even after such a large drop in price, given around half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may still consider Solomon Systech (International) as a stock to potentially avoid with its 13.3x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.
For instance, Solomon Systech (International)'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for Solomon Systech (International)
Does Growth Match The High P/E?
In order to justify its P/E ratio, Solomon Systech (International) would need to produce impressive growth in excess of the market.
Retrospectively, the last year delivered a frustrating 29% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 24% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 23% shows it's an unpleasant look.
With this information, we find it concerning that Solomon Systech (International) is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
The Key Takeaway
Despite the recent share price weakness, Solomon Systech (International)'s P/E remains higher than most other companies. 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 Solomon Systech (International) 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.
There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Solomon Systech (International) that you should be aware of.
You might be able to find a better investment than Solomon Systech (International). If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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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.