With a price-to-earnings (or "P/E") ratio of 13.2x China Mengniu Dairy Company Limited (HKG:2319) may be sending bearish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios under 9x and even P/E's lower than 5x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.
China Mengniu Dairy hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.
Check out our latest analysis for China Mengniu Dairy
How Is China Mengniu Dairy's Growth Trending?
China Mengniu Dairy's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 7.0%. The last three years don't look nice either as the company has shrunk EPS by 19% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 11% each year over the next three years. That's shaping up to be similar to the 13% per year growth forecast for the broader market.
In light of this, it's curious that China Mengniu Dairy's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.
The Bottom Line On China Mengniu Dairy's 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.
We've established that China Mengniu Dairy currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with China Mengniu Dairy, and understanding should be part of your investment process.
You might be able to find a better investment than China Mengniu Dairy. 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.