Jiangsu Hongde Special Parts Co.,Ltd.'s (SZSE:301163) Shares Climb 25% But Its Business Is Yet to Catch Up

Jiangsu Hongde Special Parts Co.,Ltd. (SZSE:301163) shareholders would be excited to see that the share price has had a great month, posting a 25% gain and recovering from prior weakness. Taking a wider view, although not as strong as the last month, the full year gain of 19% is also fairly reasonable.

Since its price has surged higher, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 39x, you may consider Jiangsu Hongde Special PartsLtd as a stock to avoid entirely with its 69.5x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, Jiangsu Hongde Special PartsLtd's receding earnings in recent times would have to be some food for thought. 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.

Check out our latest analysis for Jiangsu Hongde Special PartsLtd

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 Jiangsu Hongde Special PartsLtd's earnings, revenue and cash flow.

Does Growth Match The High P/E?

In order to justify its P/E ratio, Jiangsu Hongde Special PartsLtd would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 46% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 67% in aggregate. 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 37% 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 Jiangsu Hongde Special PartsLtd is trading at a P/E higher than the market. 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 Final Word

Shares in Jiangsu Hongde Special PartsLtd have built up some good momentum lately, which has really inflated its 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.

We've established that Jiangsu Hongde Special PartsLtd currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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.

It is also worth noting that we have found 1 warning sign for Jiangsu Hongde Special PartsLtd that you need to take into consideration.

You might be able to find a better investment than Jiangsu Hongde Special PartsLtd. 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.