ChengDu Hi-Tech Development Co., Ltd.'s (SZSE:000628) Popularity With Investors Is Under Threat From Overpricing

ChengDu Hi-Tech Development Co., Ltd.'s (SZSE:000628) price-to-earnings (or "P/E") ratio of 42.1x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 27x and even P/E's below 16x 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 so lofty.

ChengDu Hi-Tech Development certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for ChengDu Hi-Tech Development

Although there are no analyst estimates available for ChengDu Hi-Tech Development, 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 steep as ChengDu Hi-Tech Development's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered an exceptional 69% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 37% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

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

With this information, we find it concerning that ChengDu Hi-Tech Development 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. 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 recent growth rates.

What We Can Learn From ChengDu Hi-Tech Development's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that ChengDu Hi-Tech Development currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. 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.

Before you take the next step, you should know about the 3 warning signs for ChengDu Hi-Tech Development that we have uncovered.

You might be able to find a better investment than ChengDu Hi-Tech Development. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com