Risks To Shareholder Returns Are Elevated At These Prices For Jiangxi Xinyu Guoke Technology Co., Ltd (SZSE:300722)

With a price-to-earnings (or "P/E") ratio of 71.2x Jiangxi Xinyu Guoke Technology Co., Ltd (SZSE:300722) may be sending very bearish signals at the moment, given that almost half of all companies in China have P/E ratios under 27x and even P/E's lower than 16x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Earnings have risen at a steady rate over the last year for Jiangxi Xinyu Guoke Technology, which is generally not a bad outcome. It might be that many expect the reasonable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Jiangxi Xinyu Guoke Technology

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 Jiangxi Xinyu Guoke Technology's earnings, revenue and cash flow.

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

In order to justify its P/E ratio, Jiangxi Xinyu Guoke Technology would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a decent 7.4% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 39% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

This is in contrast to the rest of the market, which is expected to grow by 36% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Jiangxi Xinyu Guoke Technology is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Final Word

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 Jiangxi Xinyu Guoke Technology currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely 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.

A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Jiangxi Xinyu Guoke Technology with six simple checks on some of these key factors.

If you're unsure about the strength of Jiangxi Xinyu Guoke Technology'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.