Guotai Junan International Holdings Limited's (HKG:1788) price-to-earnings (or "P/E") ratio of 30.4x 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. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
Recent times have been quite advantageous for Guotai Junan International Holdings as its earnings have been rising very briskly. It seems that many are expecting the strong earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.
Check out our latest analysis for Guotai Junan International Holdings
Does Growth Match The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Guotai Junan International Holdings' to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 71% last year. Still, incredibly EPS has fallen 68% in total from three years ago, which is quite disappointing. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Comparing that to the market, which is predicted to deliver 19% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.
In light of this, it's alarming that Guotai Junan International Holdings' P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
The Key Takeaway
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.
Our examination of Guotai Junan International Holdings revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.
Having said that, be aware Guotai Junan International Holdings is showing 1 warning sign in our investment analysis, you should know about.
Of course, you might also be able to find a better stock than Guotai Junan International Holdings. 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.