What DHC Software Co.,Ltd.'s (SZSE:002065) 27% Share Price Gain Is Not Telling You

DHC Software Co.,Ltd. (SZSE:002065) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 57% in the last year.

Since its price has surged higher, DHC SoftwareLtd's price-to-earnings (or "P/E") ratio of 69.4x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 35x and even P/E's below 20x are quite common. 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.

For example, consider that DHC SoftwareLtd's financial performance has been poor lately as its earnings have been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out 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.

How Is DHC SoftwareLtd's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 14%. The last three years don't look nice either as the company has shrunk EPS by 38% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 38% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that DHC SoftwareLtd is trading at a P/E higher than the market. 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. 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 Bottom Line On DHC SoftwareLtd's P/E

The strong share price surge has got DHC SoftwareLtd's P/E rushing to great heights as well. 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.

We've established that DHC SoftwareLtd currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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.

Having said that, be aware DHC SoftwareLtd is showing 3 warning signs in our investment analysis, and 1 of those is concerning.

If you're unsure about the strength of DHC SoftwareLtd's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.