It's A Story Of Risk Vs Reward With GEM Co., Ltd. (SZSE:002340)

When close to half the companies in China have price-to-earnings ratios (or "P/E's") above 39x, you may consider GEM Co., Ltd. (SZSE:002340) as an attractive investment with its 27.5x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

GEM certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

See our latest analysis for GEM

If you'd like to see what analysts are forecasting going forward, you should check out our free report on GEM.

How Is GEM's Growth Trending?

In order to justify its P/E ratio, GEM would need to produce sluggish growth that's trailing the market.

If we review the last year of earnings growth, the company posted a terrific increase of 51%. The latest three year period has also seen an excellent 47% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next year should generate growth of 41% as estimated by the eight analysts watching the company. With the market only predicted to deliver 37%, the company is positioned for a stronger earnings result.

With this information, we find it odd that GEM is trading at a P/E lower than the market. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

The Final Word

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 GEM currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. At least price risks look to be very low, but investors seem to think future earnings could see a lot of volatility.

Having said that, be aware GEM is showing 3 warning signs in our investment analysis, and 2 of those make us uncomfortable.

If you're unsure about the strength of GEM'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.