Wuxi Honghui New Materials Technology Co., Ltd.'s (SZSE:002802) 25% Price Boost Is Out Of Tune With Earnings

The Wuxi Honghui New Materials Technology Co., Ltd. (SZSE:002802) share price has done very well over the last month, posting an excellent gain of 25%. Looking back a bit further, it's encouraging to see the stock is up 46% in the last year.

Following the firm bounce in price, Wuxi Honghui New Materials Technology's price-to-earnings (or "P/E") ratio of 44.7x 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 37x and even P/E's below 21x 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 as high as it is.

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For example, consider that Wuxi Honghui New Materials Technology'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Wuxi Honghui New Materials Technology

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 Wuxi Honghui New Materials Technology's earnings, revenue and cash flow.

Does Growth Match The High P/E?

Wuxi Honghui New Materials Technology's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

Retrospectively, the last year delivered a frustrating 6.0% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 30% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 36% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that Wuxi Honghui New Materials Technology 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

Wuxi Honghui New Materials Technology's P/E is getting right up there since its shares have risen strongly. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Wuxi Honghui New Materials Technology 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. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. 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.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Wuxi Honghui New Materials Technology (1 is a bit concerning!) that you need to be mindful of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.