Weichai Power Co., Ltd. (HKG:2338) shares have continued their recent momentum with a 26% gain in the last month alone. Unfortunately, despite the strong performance over the last month, the full year gain of 9.0% isn't as attractive.
In spite of the firm bounce in price, you could still be forgiven for feeling indifferent about Weichai Power's P/E ratio of 12x, since the median price-to-earnings (or "P/E") ratio in Hong Kong is also close to 11x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.
Recent times have been advantageous for Weichai Power as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. 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.
View our latest analysis for Weichai Power
Does Growth Match The P/E?
There's an inherent assumption that a company should be matching the market for P/E ratios like Weichai Power's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 35% last year. Still, EPS has barely risen at all from three years ago in total, which is not ideal. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Turning to the outlook, the next year should generate growth of 15% as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 21%, which is noticeably more attractive.
With this information, we find it interesting that Weichai Power is trading at a fairly similar P/E to the market. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.
The Key Takeaway
Its shares have lifted substantially and now Weichai Power's P/E is also back up to the market median. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.
We've established that Weichai Power 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. Unless these conditions improve, it's challenging to accept these prices as being reasonable.
Before you take the next step, you should know about the 1 warning sign for Weichai Power that we have uncovered.
You might be able to find a better investment than Weichai Power. 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).
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.