Zhejiang Huamei Holding CO., LTD.'s (SZSE:000607) Shares May Have Run Too Fast Too Soon

When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 29x, you may consider Zhejiang Huamei Holding CO., LTD. (SZSE:000607) as a stock to potentially avoid with its 43.1x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Zhejiang Huamei Holding'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.

Check out our latest analysis for Zhejiang Huamei Holding

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 Zhejiang Huamei Holding's earnings, revenue and cash flow.

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

There's an inherent assumption that a company should outperform the market for P/E ratios like Zhejiang Huamei Holding's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 8.6% decrease to the company's bottom line. At least EPS has managed not to go completely backwards from three years ago in aggregate, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

This is in contrast to the rest of the market, which is expected to grow by 38% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Zhejiang Huamei Holding is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Zhejiang Huamei Holding currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Zhejiang Huamei Holding, and understanding these should be part of your investment process.

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.