Risks To Shareholder Returns Are Elevated At These Prices For China XD Electric Co., Ltd (SHSE:601179)

With a price-to-earnings (or "P/E") ratio of 40.4x China XD Electric Co., Ltd (SHSE:601179) may be sending bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 28x 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 elevated P/E.

With earnings growth that's superior to most other companies of late, China XD Electric has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

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Is There Enough Growth For China XD Electric?

The only time you'd be truly comfortable seeing a P/E as high as China XD Electric's is when the company's growth is on track to outshine the market.

If we review the last year of earnings growth, the company posted a terrific increase of 33%. Pleasingly, EPS has also lifted 198% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 25% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 24% per annum, which is not materially different.

In light of this, it's curious that China XD Electric's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as this level of earnings growth is likely to weigh down the share price eventually.

The Bottom Line On China XD Electric's P/E

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.

Our examination of China XD Electric's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

It is also worth noting that we have found 1 warning sign for China XD Electric that you need to take into consideration.

If you're unsure about the strength of China XD Electric'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com