Shenzhen Kaifa Technology Co., Ltd.'s (SZSE:000021) Shares Climb 38% But Its Business Is Yet to Catch Up

Shenzhen Kaifa Technology Co., Ltd. (SZSE:000021) shareholders would be excited to see that the share price has had a great month, posting a 38% gain and recovering from prior weakness. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

Since its price has surged higher, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 33x, you may consider Shenzhen Kaifa Technology as a stock to potentially avoid with its 40.1x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's exceedingly strong of late, Shenzhen Kaifa Technology has been doing very well. 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. If not, then existing shareholders might be a little nervous about the viability of the share price.

See our latest analysis for Shenzhen Kaifa Technology

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

How Is Shenzhen Kaifa Technology's Growth Trending?

In order to justify its P/E ratio, Shenzhen Kaifa Technology would need to produce impressive growth in excess of the market.

Retrospectively, the last year delivered an exceptional 42% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 28% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 37% shows it's an unpleasant look.

In light of this, it's alarming that Shenzhen Kaifa Technology's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Final Word

Shenzhen Kaifa Technology's P/E is getting right up there since its shares have risen strongly. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Shenzhen Kaifa Technology 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. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. 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 1 warning sign with Shenzhen Kaifa Technology, and understanding should be part of your investment process.

If these risks are making you reconsider your opinion on Shenzhen Kaifa Technology, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.