Cheerwin Group Limited (HKG:6601) shares have had a really impressive month, gaining 30% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 67%.
Following the firm bounce in price, Cheerwin Group's price-to-earnings (or "P/E") ratio of 13.4x might make it look like a 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 elevated P/E.
With earnings growth that's superior to most other companies of late, Cheerwin Group 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 Cheerwin Group
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Cheerwin Group would need to produce impressive growth in excess of the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 93% last year. The latest three year period has also seen a 12% overall rise in EPS, aided extensively by its short-term performance. Therefore, it's fair to say the earnings growth recently has been respectable for the company.
Looking ahead now, EPS is anticipated to climb by 3.4% each year during the coming three years according to the dual analysts following the company. With the market predicted to deliver 12% growth per year, the company is positioned for a weaker earnings result.
With this information, we find it concerning that Cheerwin Group 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 Key Takeaway
Cheerwin Group's P/E is getting right up there since its shares have risen strongly. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
We've established that Cheerwin Group currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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.
Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Cheerwin Group that you should be aware of.
If these risks are making you reconsider your opinion on Cheerwin Group, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.