The Lafang China Co.,Ltd (SHSE:603630) share price has fared very poorly over the last month, falling by a substantial 27%. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 24% share price drop.
Although its price has dipped substantially, Lafang ChinaLtd's price-to-earnings (or "P/E") ratio of 35.1x might still make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 27x and even P/E's below 17x 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 as high as it is.
Lafang ChinaLtd has been doing a decent job lately as it's been growing earnings at a reasonable pace. One possibility is that the P/E is high because investors think this good earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
How Is Lafang ChinaLtd's Growth Trending?
The only time you'd be truly comfortable seeing a P/E as high as Lafang ChinaLtd's is when the company's growth is on track to outshine the market.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 5.8% last year. However, due to its less than impressive performance prior to this period, EPS growth is practically non-existent over the last three years overall. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's noticeably less attractive on an annualised basis.
With this information, we find it concerning that Lafang ChinaLtd 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
Lafang ChinaLtd's P/E hasn't come down all the way after its stock plunged. 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 Lafang ChinaLtd revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. 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.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Lafang ChinaLtd (at least 1 which is a bit unpleasant), and understanding them should be part of your investment process.
If these risks are making you reconsider your opinion on Lafang ChinaLtd, explore our interactive list of high quality stocks to get an idea of what else is out there.
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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.