Risks To Shareholder Returns Are Elevated At These Prices For Wuxi Honghui New Materials Technology Co., Ltd. (SZSE:002802)

It's not a stretch to say that Wuxi Honghui New Materials Technology Co., Ltd.'s (SZSE:002802) price-to-earnings (or "P/E") ratio of 34.9x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 33x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

For example, consider that Wuxi Honghui New Materials Technology's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

View our latest analysis for Wuxi Honghui New Materials Technology

Although there are no analyst estimates available for Wuxi Honghui New Materials Technology, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

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

In order to justify its P/E ratio, Wuxi Honghui New Materials Technology would need to produce growth that's similar to the market.

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 21%. This means it has also seen a slide in earnings over the longer-term as EPS is down 47% in total over the last three years. 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 37% shows it's an unpleasant look.

With this information, we find it concerning that Wuxi Honghui New Materials Technology is trading at a fairly similar P/E to 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 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 Bottom Line On Wuxi Honghui New Materials Technology's P/E

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 Wuxi Honghui New Materials Technology revealed its shrinking earnings over the medium-term aren't impacting its P/E 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 moderate P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Wuxi Honghui New Materials Technology (1 is potentially serious) 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.