The Shanxi Guoxin Energy Corporation Limited (SHSE:600617) share price has fared very poorly over the last month, falling by a substantial 26%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 31% in that time.
In spite of the heavy fall in price, Shanxi Guoxin Energy may still be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 77.5x, since almost half of all companies in China have P/E ratios under 26x and even P/E's lower than 16x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Shanxi Guoxin Energy has been doing a good job lately as it's been growing earnings at a solid pace. One possibility is that the P/E is high because investors think this respectable 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 Shanxi Guoxin Energy's Growth Trending?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Shanxi Guoxin Energy's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 17% last year. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Comparing that to the market, which is predicted to deliver 41% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.
With this information, we find it concerning that Shanxi Guoxin Energy 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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.
What We Can Learn From Shanxi Guoxin Energy's P/E?
Even after such a strong price drop, Shanxi Guoxin Energy's P/E still exceeds the rest of the market significantly. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that Shanxi Guoxin Energy currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shanxi Guoxin Energy (at least 1 which makes us a bit uncomfortable), and understanding them should be part of your investment process.
If you're unsure about the strength of Shanxi Guoxin Energy's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.
