Lafang China Co.,Ltd (SHSE:603630) Stock Rockets 26% As Investors Are Less Pessimistic Than Expected

The Lafang China Co.,Ltd (SHSE:603630) share price has done very well over the last month, posting an excellent gain of 26%. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 20% over that time.

Since its price has surged higher, Lafang ChinaLtd may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 54.5x, since almost half of all companies in China have P/E ratios under 33x and even P/E's lower than 19x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Lafang ChinaLtd'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 Lafang ChinaLtd

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

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Lafang ChinaLtd's is when the company's growth is on track to outshine the market decidedly.

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 27%. As a result, earnings from three years ago have also fallen 60% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 37% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Lafang ChinaLtd'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

The strong share price surge has got Lafang ChinaLtd's P/E rushing to great heights as well. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Lafang ChinaLtd 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.

It is also worth noting that we have found 4 warning signs for Lafang ChinaLtd (1 makes us a bit uncomfortable!) that you need to take into consideration.

You might be able to find a better investment than Lafang ChinaLtd. 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.