Optimistic Investors Push Huarong Chemical Co., Ltd. (SZSE:301256) Shares Up 32% But Growth Is Lacking

The Huarong Chemical Co., Ltd. (SZSE:301256) share price has done very well over the last month, posting an excellent gain of 32%. The last 30 days bring the annual gain to a very sharp 52%.

Since its price has surged higher, Huarong Chemical's price-to-earnings (or "P/E") ratio of 52.1x 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 38x and even P/E's below 21x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For instance, Huarong Chemical'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Huarong Chemical

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

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as Huarong Chemical's is when the company's growth is on track to outshine the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 28%. As a result, earnings from three years ago have also fallen 25% 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 Huarong Chemical 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

Huarong Chemical shares have received a push in the right direction, but its P/E is elevated too. 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.

Our examination of Huarong Chemical 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you settle on your opinion, we've discovered 3 warning signs for Huarong Chemical (2 are significant!) that you should be aware 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.