Guangdong Shirongzhaoye Co., Ltd.'s (SZSE:002016) Shares Climb 26% But Its Business Is Yet to Catch Up

The Guangdong Shirongzhaoye Co., Ltd. (SZSE:002016) share price has done very well over the last month, posting an excellent gain of 26%. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 2.2% over the last year.

Following the firm bounce in price, Guangdong Shirongzhaoye's price-to-earnings (or "P/E") ratio of 35.1x 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 31x and even P/E's below 19x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Earnings have risen firmly for Guangdong Shirongzhaoye recently, which is pleasing to see. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Guangdong Shirongzhaoye

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Guangdong Shirongzhaoye will help you shine a light on its historical performance.

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

In order to justify its P/E ratio, Guangdong Shirongzhaoye would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a worthy increase of 9.8%. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 80% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 38% shows it's an unpleasant look.

In light of this, it's alarming that Guangdong Shirongzhaoye's P/E sits above the majority of other companies. 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. 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.

What We Can Learn From Guangdong Shirongzhaoye's P/E?

Guangdong Shirongzhaoye's P/E is getting right up there since its shares have risen strongly. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Guangdong Shirongzhaoye 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. 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 3 warning signs with Guangdong Shirongzhaoye (at least 2 which make us uncomfortable), and understanding these should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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

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.