What Jiangsu Rainbow Heavy Industries Co., Ltd.'s (SZSE:002483) 27% Share Price Gain Is Not Telling You

Despite an already strong run, Jiangsu Rainbow Heavy Industries Co., Ltd. (SZSE:002483) shares have been powering on, with a gain of 27% in the last thirty days. The last 30 days bring the annual gain to a very sharp 69%.

Since its price has surged higher, Jiangsu Rainbow Heavy Industries' price-to-earnings (or "P/E") ratio of 74.5x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 39x and even P/E's below 22x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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For example, consider that Jiangsu Rainbow Heavy Industries' financial performance has been poor lately as its earnings have been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Jiangsu Rainbow Heavy Industries

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

Is There Enough Growth For Jiangsu Rainbow Heavy Industries?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Jiangsu Rainbow Heavy Industries' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 12%. This means it has also seen a slide in earnings over the longer-term as EPS is down 74% 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 37% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Jiangsu Rainbow Heavy Industries' P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Shares in Jiangsu Rainbow Heavy Industries have built up some good momentum lately, which has really inflated its P/E. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Jiangsu Rainbow Heavy Industries revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. 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.

There are also other vital risk factors to consider before investing and we've discovered 3 warning signs for Jiangsu Rainbow Heavy Industries that you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.