There's Reason For Concern Over Changzhou Evergreen Technology Co., Ltd.'s (SZSE:001324) Massive 26% Price Jump

Changzhou Evergreen Technology Co., Ltd. (SZSE:001324) shares have continued their recent momentum with a 26% gain in the last month alone. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 17% over that time.

After such a large jump in price, Changzhou Evergreen Technology's price-to-earnings (or "P/E") ratio of 46.1x 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 36x and even P/E's below 21x are quite common. 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 Changzhou Evergreen Technology over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for Changzhou Evergreen Technology

Although there are no analyst estimates available for Changzhou Evergreen Technology, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Is There Enough Growth For Changzhou Evergreen Technology?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 39%. This means it has also seen a slide in earnings over the longer-term as EPS is down 30% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 39% 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 Changzhou Evergreen Technology is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Final Word

The large bounce in Changzhou Evergreen Technology'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 Changzhou Evergreen Technology 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.

You always need to take note of risks, for example - Changzhou Evergreen Technology has 2 warning signs we think you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.