Shanxi Yongdong Chemistry Industry Co., Ltd.'s (SZSE:002753) Popularity With Investors Is Under Threat From Overpricing

Shanxi Yongdong Chemistry Industry Co., Ltd.'s (SZSE:002753) price-to-earnings (or "P/E") ratio of 54.3x 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 30x and even P/E's below 19x 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 instance, Shanxi Yongdong Chemistry Industry's receding earnings in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

See our latest analysis for Shanxi Yongdong Chemistry Industry

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

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

In order to justify its P/E ratio, Shanxi Yongdong Chemistry Industry would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 56%. The last three years don't look nice either as the company has shrunk EPS by 51% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 38% shows it's an unpleasant look.

With this information, we find it concerning that Shanxi Yongdong Chemistry Industry is trading at a P/E higher than the market. 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

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Shanxi Yongdong Chemistry Industry 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 should always think about risks. Case in point, we've spotted 2 warning signs for Shanxi Yongdong Chemistry Industry you should be aware of, and 1 of them is concerning.

You might be able to find a better investment than Shanxi Yongdong Chemistry Industry. 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.