When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider China Tobacco International (HK) Company Limited (HKG:6055) as a stock to avoid entirely with its 21.6x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's superior to most other companies of late, China Tobacco International (HK) has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.
View our latest analysis for China Tobacco International (HK)
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, China Tobacco International (HK) would need to produce outstanding growth well in excess of the market.
Retrospectively, the last year delivered an exceptional 28% gain to the company's bottom line. EPS has also lifted 18% in aggregate from three years ago, mostly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing earnings over that time.
Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 11% per annum over the next three years. With the market predicted to deliver 13% growth each year, the company is positioned for a comparable earnings result.
With this information, we find it interesting that China Tobacco International (HK) is trading at a high P/E compared to the market. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.
What We Can Learn From China Tobacco International (HK)'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.
Our examination of China Tobacco International (HK)'s analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. 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.
Don't forget that there may be other risks. For instance, we've identified 1 warning sign for China Tobacco International (HK) that you should be aware of.
Of course, you might also be able to find a better stock than China Tobacco International (HK). 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.