Red Avenue New Materials Group Co., Ltd.'s (SHSE:603650) Shares May Have Run Too Fast Too Soon

Red Avenue New Materials Group Co., Ltd.'s (SHSE:603650) price-to-earnings (or "P/E") ratio of 41.8x 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 28x and even P/E's below 17x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent times have been pleasing for Red Avenue New Materials Group as its earnings have risen in spite of the market's earnings going into reverse. 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.

View our latest analysis for Red Avenue New Materials Group

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Red Avenue New Materials Group.

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

In order to justify its P/E ratio, Red Avenue New Materials Group would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 43%. The latest three year period has also seen a 21% overall rise in EPS, aided extensively by its short-term performance. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Turning to the outlook, the next year should generate growth of 18% as estimated by the four analysts watching the company. That's shaping up to be materially lower than the 41% growth forecast for the broader market.

With this information, we find it concerning that Red Avenue New Materials Group is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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 Final Word

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 Red Avenue New Materials Group's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you take the next step, you should know about the 1 warning sign for Red Avenue New Materials Group that we have uncovered.

If you're unsure about the strength of Red Avenue New Materials Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.