Unpleasant Surprises Could Be In Store For China Southern Power Grid Technology Co.,Ltd's (SHSE:688248) Shares

China Southern Power Grid Technology Co.,Ltd's (SHSE:688248) price-to-earnings (or "P/E") ratio of 42.3x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 34x and even P/E's below 20x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With its earnings growth in positive territory compared to the declining earnings of most other companies, China Southern Power Grid TechnologyLtd has been doing quite well of late. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for China Southern Power Grid TechnologyLtd

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What Are Growth Metrics Telling Us About The High P/E?

China Southern Power Grid TechnologyLtd's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 81% last year. The latest three year period has also seen an excellent 137% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next year should generate growth of 38% as estimated by the seven analysts watching the company. With the market predicted to deliver 38% growth , the company is positioned for a comparable earnings result.

In light of this, it's curious that China Southern Power Grid TechnologyLtd'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. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

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 China Southern Power Grid TechnologyLtd currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for China Southern Power Grid TechnologyLtd with six simple checks on some of these key factors.

You might be able to find a better investment than China Southern Power Grid TechnologyLtd. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.