Shanghai Challenge Textile Co.,Ltd.'s (SZSE:002486) 29% Share Price Surge Not Quite Adding Up

Shanghai Challenge Textile Co.,Ltd. (SZSE:002486) shareholders have had their patience rewarded with a 29% share price jump in the last month. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 36% in the last twelve months.

Since its price has surged higher, Shanghai Challenge TextileLtd may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 32.3x, since almost half of all companies in China have P/E ratios under 26x and even P/E's lower than 16x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

For instance, Shanghai Challenge TextileLtd'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. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for Shanghai Challenge TextileLtd

Although there are no analyst estimates available for Shanghai Challenge TextileLtd, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Shanghai Challenge TextileLtd's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as high as Shanghai Challenge TextileLtd's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a frustrating 52% decrease to the company's bottom line. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that Shanghai Challenge TextileLtd'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. 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

The large bounce in Shanghai Challenge TextileLtd's shares has lifted the company's P/E to a fairly high level. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

Our examination of Shanghai Challenge TextileLtd revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, 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.

Having said that, be aware Shanghai Challenge TextileLtd is showing 2 warning signs in our investment analysis, you should know about.

Of course, you might also be able to find a better stock than Shanghai Challenge TextileLtd. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.