Chengdu Qushui Science and Technology Co., Ltd.'s (SZSE:301336) 33% Share Price Surge Not Quite Adding Up

Chengdu Qushui Science and Technology Co., Ltd. (SZSE:301336) shareholders would be excited to see that the share price has had a great month, posting a 33% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 18% over that time.

Since its price has surged higher, Chengdu Qushui Science and Technology's price-to-earnings (or "P/E") ratio of 56.9x 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 31x and even P/E's below 18x 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 example, consider that Chengdu Qushui Science and Technology'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Chengdu Qushui Science and Technology

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Chengdu Qushui Science and Technology will help you shine a light on its historical performance.

How Is Chengdu Qushui Science and Technology's Growth Trending?

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

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 8.8%. The last three years don't look nice either as the company has shrunk EPS by 72% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 37% 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 Chengdu Qushui Science and Technology'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 Key Takeaway

Chengdu Qushui Science and Technology's P/E is flying high just like its stock has during the last month. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Chengdu Qushui Science and Technology 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. 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.

You need to take note of risks, for example - Chengdu Qushui Science and Technology has 2 warning signs (and 1 which can't be ignored) we think you should know about.

You might be able to find a better investment than Chengdu Qushui Science and Technology. 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.