What Guangzhou Huayan Precision Machinery Co.,Ltd.'s (SZSE:301138) P/E Is Not Telling You

Guangzhou Huayan Precision Machinery Co.,Ltd.'s (SZSE:301138) price-to-earnings (or "P/E") ratio of 40.3x 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 28x and even P/E's below 17x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Guangzhou Huayan Precision MachineryLtd's 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for Guangzhou Huayan Precision MachineryLtd

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 Guangzhou Huayan Precision MachineryLtd's earnings, revenue and cash flow.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Guangzhou Huayan Precision MachineryLtd would need to produce impressive growth in excess of the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 21%. This means it has also seen a slide in earnings over the longer-term as EPS is down 36% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's an unpleasant look.

With this information, we find it concerning that Guangzhou Huayan Precision MachineryLtd 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.

What We Can Learn From Guangzhou Huayan Precision MachineryLtd's 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.

We've established that Guangzhou Huayan Precision MachineryLtd 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Guangzhou Huayan Precision MachineryLtd (2 are concerning!) that you should be aware of before investing here.

If these risks are making you reconsider your opinion on Guangzhou Huayan Precision MachineryLtd, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com