China Display Optoelectronics Technology Holdings Limited (HKG:334) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Unfortunately, despite the strong performance over the last month, the full year gain of 4.8% isn't as attractive.
After such a large jump in price, China Display Optoelectronics Technology Holdings' price-to-earnings (or "P/E") ratio of 17x might make it look like a strong 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 highly elevated P/E.
For example, consider that China Display Optoelectronics Technology Holdings' financial performance has been pretty ordinary lately as earnings growth is non-existent. 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 Display Optoelectronics Technology Holdings
How Is China Display Optoelectronics Technology Holdings' Growth Trending?
There's an inherent assumption that a company should far outperform the market for P/E ratios like China Display Optoelectronics Technology Holdings' to be considered reasonable.
If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. This isn't what shareholders were looking for as it means they've been left with a 62% decline in EPS over the last three years in total. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Comparing that to the market, which is predicted to deliver 23% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.
With this information, we find it concerning that China Display Optoelectronics Technology Holdings 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. 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.
What We Can Learn From China Display Optoelectronics Technology Holdings' P/E?
Shares in China Display Optoelectronics Technology Holdings have built up some good momentum lately, which has really inflated its P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
Our examination of China Display Optoelectronics Technology Holdings revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
You need to take note of risks, for example - China Display Optoelectronics Technology Holdings has 3 warning signs (and 1 which is potentially serious) we think you should know about.
You might be able to find a better investment than China Display Optoelectronics Technology Holdings. 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.