Rainbow Digital Commercial Co., Ltd.'s (SZSE:002419) P/E Still Appears To Be Reasonable

When close to half the companies in China have price-to-earnings ratios (or "P/E's") below 35x, you may consider Rainbow Digital Commercial Co., Ltd. (SZSE:002419) as a stock to potentially avoid with its 49.5x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent times haven't been advantageous for Rainbow Digital Commercial as its earnings have been falling quicker than most other companies. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Rainbow Digital Commercial

Want the full picture on analyst estimates for the company? Then our free report on Rainbow Digital Commercial will help you uncover what's on the horizon.

Is There Enough Growth For Rainbow Digital Commercial?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 48%. This means it has also seen a slide in earnings over the longer-term as EPS is down 68% 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.

Turning to the outlook, the next year should generate growth of 60% as estimated by the three analysts watching the company. That's shaping up to be materially higher than the 40% growth forecast for the broader market.

With this information, we can see why Rainbow Digital Commercial is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Bottom Line On Rainbow Digital Commercial's P/E

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 Rainbow Digital Commercial maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Rainbow Digital Commercial, and understanding these should be part of your investment process.

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.

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.