There's Reason For Concern Over Tungkong Inc.'s (SZSE:002117) Massive 28% Price Jump

Tungkong Inc. (SZSE:002117) shares have continued their recent momentum with a 28% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 59% in the last year.

After such a large jump in price, Tungkong's price-to-earnings (or "P/E") ratio of 63.5x 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 33x and even P/E's below 19x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

For instance, Tungkong's receding earnings in recent times would have to be some food for thought. 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.

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How Is Tungkong's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 28%. The last three years don't look nice either as the company has shrunk EPS by 40% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 38% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's alarming that Tungkong's P/E sits above the majority of other companies. 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. 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 Key Takeaway

Tungkong's P/E is flying high just like its stock has during the last month. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Tungkong 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. 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.

It is also worth noting that we have found 3 warning signs for Tungkong (1 is significant!) that you need to take into consideration.

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