There wouldn't be many who think Hengan International Group Company Limited's (HKG:1044) price-to-earnings (or "P/E") ratio of 9.9x is worth a mention when the median P/E in Hong Kong is similar at about 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.
We've discovered 1 warning sign about Hengan International Group. View them for free.Hengan International Group hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to strengthen positively, which has kept the P/E from falling. If not, then existing shareholders may be a little nervous about the viability of the share price.
View our latest analysis for Hengan International Group
What Are Growth Metrics Telling Us About The P/E?
In order to justify its P/E ratio, Hengan International Group would need to produce growth that's similar to the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 17%. This means it has also seen a slide in earnings over the longer-term as EPS is down 29% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 3.8% per annum during the coming three years according to the nine analysts following the company. That's shaping up to be materially lower than the 14% each year growth forecast for the broader market.
With this information, we find it interesting that Hengan International Group 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
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.
Our examination of Hengan International Group's analyst forecasts revealed that its inferior earnings outlook isn't impacting its P/E as much as we would have predicted. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. 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 - Hengan International Group has 1 warning sign we think you should be aware of.
You might be able to find a better investment than Hengan International 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.