NetEase, Inc.'s (HKG:9999) price-to-earnings (or "P/E") ratio of 16.7x 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. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
We check all companies for important risks. See what we found for NetEase in our free report.NetEase's earnings growth of late has been pretty similar to most other companies. One possibility is that the P/E is high because investors think this modest earnings performance will accelerate. If not, then existing shareholders may be a little nervous about the viability of the share price.
View our latest analysis for NetEase
How Is NetEase's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as steep as NetEase's is when the company's growth is on track to outshine the market decidedly.
Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. Although pleasingly EPS has lifted 85% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
Looking ahead now, EPS is anticipated to climb by 8.6% per year during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 14% each year growth forecast for the broader market.
In light of this, it's alarming that NetEase's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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 Bottom Line On NetEase's P/E
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 NetEase's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for NetEase with six simple checks on some of these key factors.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.