Unfortunately for some shareholders, the New East New Materials Co., Ltd (SHSE:603110) share price has dived 28% in the last thirty days, prolonging recent pain. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 49% in that time.
In spite of the heavy fall in price, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may still consider New East New Materials as a stock to avoid entirely with its 53.1x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.
With earnings growth that's exceedingly strong of late, New East New Materials has been doing very well. The P/E is probably high because investors think this strong 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.
Does Growth Match The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like New East New Materials' to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 160% last year. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
This is in contrast to the rest of the market, which is expected to grow by 36% over the next year, materially higher than the company's recent medium-term annualised growth rates.
With this information, we find it concerning that New East New Materials is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 New East New Materials' P/E?
Even after such a strong price drop, New East New Materials' P/E still exceeds the rest of the market significantly. 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.
We've established that New East New Materials 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. 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.
You always need to take note of risks, for example - New East New Materials has 2 warning signs we think you should be aware of.
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.