Haidilao International Holding Ltd.'s (HKG:6862) price-to-earnings (or "P/E") ratio of 18.2x 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 10x and even P/E's below 6x 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.
With earnings growth that's superior to most other companies of late, Haidilao International Holding has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for Haidilao International Holding
Does Growth Match The High P/E?
The only time you'd be truly comfortable seeing a P/E as steep as Haidilao International Holding's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered a decent 12% gain to the company's bottom line. Pleasingly, EPS has also lifted 197% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.
Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 9.5% per annum over the next three years. That's shaping up to be materially lower than the 13% per year growth forecast for the broader market.
With this information, we find it concerning that Haidilao International Holding is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.
The Final Word
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 Haidilao International Holding's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Haidilao International Holding, and understanding should be part of your investment process.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.