Longhorn Auto Co., Ltd.'s (SZSE:301488) Shares Climb 26% But Its Business Is Yet to Catch Up

Longhorn Auto Co., Ltd. (SZSE:301488) shares have had a really impressive month, gaining 26% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 55%.

After such a large jump in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 34x, you may consider Longhorn Auto as a stock to potentially avoid with its 52.1x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Longhorn Auto 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.

Check out our latest analysis for Longhorn Auto

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Longhorn Auto will help you shine a light on its historical performance.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Longhorn Auto would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered a frustrating 9.9% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 11% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 38% shows it's an unpleasant look.

With this information, we find it concerning that Longhorn Auto 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 large bounce in Longhorn Auto's shares has lifted the company's P/E to a fairly high level. 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 Longhorn Auto currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely 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.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Longhorn Auto that you need to be mindful of.

If these risks are making you reconsider your opinion on Longhorn Auto, 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.