There's Reason For Concern Over Zhejiang Kan Specialities Material Co., Ltd.'s (SZSE:002012) Massive 26% Price Jump

Zhejiang Kan Specialities Material Co., Ltd. (SZSE:002012) shareholders are no doubt pleased to see that the share price has bounced 26% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 25% over that time.

Since its price has surged higher, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 30x, you may consider Zhejiang Kan Specialities Material as a stock to potentially avoid with its 38.4x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

For example, consider that Zhejiang Kan Specialities Material'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.

See our latest analysis for Zhejiang Kan Specialities Material

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Zhejiang Kan Specialities Material's earnings, revenue and cash flow.

Does Growth Match The High P/E?

There's an inherent assumption that a company should outperform the market for P/E ratios like Zhejiang Kan Specialities Material'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 46%. The last three years don't look nice either as the company has shrunk EPS by 26% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's an unpleasant look.

In light of this, it's alarming that Zhejiang Kan Specialities Material'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. 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 large bounce in Zhejiang Kan Specialities Material's shares has lifted the company's P/E to a fairly high level. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Zhejiang Kan Specialities Material 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.

You should always think about risks. Case in point, we've spotted 1 warning sign for Zhejiang Kan Specialities Material you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.