There's Reason For Concern Over Chengdu Leejun Industrial Co., Ltd.'s (SZSE:002651) Massive 30% Price Jump

Those holding Chengdu Leejun Industrial Co., Ltd. (SZSE:002651) shares would be relieved that the share price has rebounded 30% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 25% in the last twelve months.

Following the firm bounce in price, Chengdu Leejun Industrial may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 49.3x, since almost half of all companies in China have P/E ratios under 29x and even P/E's lower than 18x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

As an illustration, earnings have deteriorated at Chengdu Leejun Industrial 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.

View our latest analysis for Chengdu Leejun Industrial

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Chengdu Leejun Industrial's earnings, revenue and cash flow.

Is There Enough Growth For Chengdu Leejun Industrial?

The only time you'd be truly comfortable seeing a P/E as steep as Chengdu Leejun Industrial's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 43%. The last three years don't look nice either as the company has shrunk EPS by 38% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 41% 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 Chengdu Leejun Industrial's 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. 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 strong share price surge has got Chengdu Leejun Industrial's P/E rushing to great heights as well. 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 Chengdu Leejun Industrial currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. 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.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Chengdu Leejun Industrial that you need to be mindful of.

You might be able to find a better investment than Chengdu Leejun Industrial. 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.