Three Squirrels Inc.'s (SZSE:300783) 29% Price Boost Is Out Of Tune With Earnings

Three Squirrels Inc. (SZSE:300783) shareholders would be excited to see that the share price has had a great month, posting a 29% gain and recovering from prior weakness. Looking further back, the 13% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

After such a large jump in price, Three Squirrels' price-to-earnings (or "P/E") ratio of 42.4x 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 29x and even P/E's below 18x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Three Squirrels certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, 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.

Check out our latest analysis for Three Squirrels

Keen to find out how analysts think Three Squirrels' future stacks up against the industry? In that case, our free report is a great place to start.

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

Three Squirrels' P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 232% last year. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Turning to the outlook, the next year should generate growth of 34% as estimated by the seven analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 41%, which is noticeably more attractive.

With this information, we find it concerning that Three Squirrels is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Three Squirrels' P/E

The large bounce in Three Squirrels' 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.

We've established that Three Squirrels currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Three Squirrels, and understanding them should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.