Espressif Systems (Shanghai) Co., Ltd.'s (SHSE:688018) 35% Price Boost Is Out Of Tune With Earnings

Despite an already strong run, Espressif Systems (Shanghai) Co., Ltd. (SHSE:688018) shares have been powering on, with a gain of 35% in the last thirty days. Notwithstanding the latest gain, the annual share price return of 6.0% isn't as impressive.

Following the firm bounce in price, Espressif Systems (Shanghai) may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 67.7x, since almost half of all companies in China have P/E ratios under 29x and even P/E's lower than 17x are not unusual. 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.

Recent times have been advantageous for Espressif Systems (Shanghai) as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

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

In order to justify its P/E ratio, Espressif Systems (Shanghai) would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered an exceptional 59% gain to the company's bottom line. As a result, it also grew EPS by 27% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 27% per annum as estimated by the five analysts watching the company. With the market predicted to deliver 25% growth per annum, the company is positioned for a comparable earnings result.

In light of this, it's curious that Espressif Systems (Shanghai)'s P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

Espressif Systems (Shanghai)'s P/E is flying high just like its stock has during the last month. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Espressif Systems (Shanghai)'s analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Before you take the next step, you should know about the 1 warning sign for Espressif Systems (Shanghai) that we have uncovered.

Of course, you might also be able to find a better stock than Espressif Systems (Shanghai). So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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