Despite an already strong run, Hangzhou Kelin Electric Co., Ltd. (SHSE:688611) shares have been powering on, with a gain of 35% in the last thirty days. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.
After such a large jump in price, Hangzhou Kelin Electric's price-to-earnings (or "P/E") ratio of 78.9x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 32x and even P/E's below 20x 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 so lofty.
As an illustration, earnings have deteriorated at Hangzhou Kelin Electric over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Hangzhou Kelin Electric would need to produce outstanding growth well in excess of the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 34%. The last three years don't look nice either as the company has shrunk EPS by 73% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
In contrast to the company, the rest of the market is expected to grow by 38% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
With this information, we find it concerning that Hangzhou Kelin Electric 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 very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.
The Key Takeaway
The strong share price surge has got Hangzhou Kelin Electric's P/E rushing to great heights as well. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that Hangzhou Kelin Electric currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.
You need to take note of risks, for example - Hangzhou Kelin Electric has 5 warning signs (and 2 which shouldn't be ignored) we think you should know about.
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.