There's Reason For Concern Over Hefei Urban Construction Development Co., Ltd's (SZSE:002208) Massive 28% Price Jump

Hefei Urban Construction Development Co., Ltd (SZSE:002208) shares have had a really impressive month, gaining 28% after a shaky period beforehand. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 6.6% in the last twelve months.

Since its price has surged higher, Hefei Urban Construction Development's price-to-earnings (or "P/E") ratio of 37.3x 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 32x and even P/E's below 20x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

As an illustration, earnings have deteriorated at Hefei Urban Construction Development over the last year, which is not ideal at all. 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 Hefei Urban Construction Development

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 Hefei Urban Construction Development'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 Hefei Urban Construction Development's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 61%. This means it has also seen a slide in earnings over the longer-term as EPS is down 86% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

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 Hefei Urban Construction Development'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.

The Final Word

Hefei Urban Construction Development's P/E is getting right up there since its shares have risen strongly. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Hefei Urban Construction Development 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.

Don't forget that there may be other risks. For instance, we've identified 4 warning signs for Hefei Urban Construction Development (2 make us uncomfortable) you should be aware of.

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.