What DHC Software Co.,Ltd.'s (SZSE:002065) 26% Share Price Gain Is Not Telling You

DHC Software Co.,Ltd. (SZSE:002065) shareholders are no doubt pleased to see that the share price has bounced 26% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 13% over that time.

After such a large jump in price, DHC SoftwareLtd may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 41.5x, since almost half of all companies in China have P/E ratios under 30x and even P/E's lower than 18x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Recent times have been quite advantageous for DHC SoftwareLtd as its earnings have been rising very briskly. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for DHC SoftwareLtd

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

Does Growth Match The High P/E?

DHC SoftwareLtd's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

If we review the last year of earnings growth, the company posted a terrific increase of 77%. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 41% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we find it concerning that DHC SoftwareLtd is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

DHC SoftwareLtd'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 DHC SoftwareLtd 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. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. 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 DHC SoftwareLtd (at least 1 which shouldn't be ignored), and understanding them should be part of your investment process.

You might be able to find a better investment than DHC SoftwareLtd. 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.