Xiamen Leading Optics Co., Ltd.'s (SHSE:605118) Shares Climb 28% But Its Business Is Yet to Catch Up

Those holding Xiamen Leading Optics Co., Ltd. (SHSE:605118) shares would be relieved that the share price has rebounded 28% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Looking back a bit further, it's encouraging to see the stock is up 31% in the last year.

Since its price has surged higher, given close to half the companies in China have price-to-earnings ratios (or "P/E's") below 30x, you may consider Xiamen Leading Optics as a stock to avoid entirely with its 59x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Xiamen Leading Optics 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Xiamen Leading Optics

Although there are no analyst estimates available for Xiamen Leading Optics, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Xiamen Leading Optics' Growth Trending?

In order to justify its P/E ratio, Xiamen Leading Optics would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a frustrating 22% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 26% 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.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 39% shows it's an unpleasant look.

In light of this, it's alarming that Xiamen Leading Optics' 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. 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.

What We Can Learn From Xiamen Leading Optics' P/E?

The strong share price surge has got Xiamen Leading Optics' P/E rushing to great heights as well. 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.

We've established that Xiamen Leading Optics 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.

You should always think about risks. Case in point, we've spotted 2 warning signs for Xiamen Leading Optics you should be aware of.

You might be able to find a better investment than Xiamen Leading Optics. 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.