China Chengtong Development Group Limited's (HKG:217) price-to-earnings (or "P/E") ratio of 15.9x 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 5x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
For instance, China Chengtong Development Group's receding earnings in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
View our latest analysis for China Chengtong Development Group
Does Growth Match The High P/E?
In order to justify its P/E ratio, China Chengtong Development Group would need to produce outstanding growth well in excess of the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 43%. As a result, earnings from three years ago have also fallen 64% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 18% shows it's an unpleasant look.
With this information, we find it concerning that China Chengtong Development Group is trading at a P/E higher than the market. 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. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.
The Final Word
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 China Chengtong Development Group 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. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
You should always think about risks. Case in point, we've spotted 3 warning signs for China Chengtong Development Group you should be aware of, and 1 of them is concerning.
You might be able to find a better investment than China Chengtong Development Group. 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).
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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.