Despite an already strong run, China Communications Services Corporation Limited (HKG:552) shares have been powering on, with a gain of 30% in the last thirty days. The last 30 days bring the annual gain to a very sharp 65%.
Even after such a large jump in price, you could still be forgiven for feeling indifferent about China Communications Services' P/E ratio of 10x, since the median price-to-earnings (or "P/E") ratio in Hong Kong is also close to 10x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
Recent times have been advantageous for China Communications Services as its earnings have been rising faster than most other companies. One possibility is that the P/E is moderate because investors think this strong earnings performance might be about to tail off. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.
See our latest analysis for China Communications Services
What Are Growth Metrics Telling Us About The P/E?
In order to justify its P/E ratio, China Communications Services would need to produce growth that's similar to the market.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 5.0% last year. EPS has also lifted 11% 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 actually done a good job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 4.7% per annum as estimated by the seven analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 13% per year, which is noticeably more attractive.
In light of this, it's curious that China Communications Services' P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as this level of earnings growth is likely to weigh down the shares eventually.
The Bottom Line On China Communications Services' P/E
China Communications Services appears to be back in favour with a solid price jump getting its P/E back in line with most other companies. 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 Communications Services currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.
You always need to take note of risks, for example - China Communications Services has 1 warning sign we think you should be aware of.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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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.