Hengbao Co.,Ltd.'s (SZSE:002104) Shares Climb 25% But Its Business Is Yet to Catch Up

The Hengbao Co.,Ltd. (SZSE:002104) share price has done very well over the last month, posting an excellent gain of 25%. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 25% over that time.

After such a large jump in price, HengbaoLtd may be sending bearish signals at the moment with its price-to-earnings (or "P/E") ratio of 36.6x, since almost half of all companies in China have P/E ratios under 26x and even P/E's lower than 16x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For example, consider that HengbaoLtd's financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

View our latest analysis for HengbaoLtd

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on HengbaoLtd's earnings, revenue and cash flow.

How Is HengbaoLtd's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 16%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's noticeably less attractive on an annualised basis.

In light of this, it's alarming that HengbaoLtd's 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 good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On HengbaoLtd's P/E

HengbaoLtd's P/E is getting right up there since its shares have risen strongly. 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 HengbaoLtd currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You should always think about risks. Case in point, we've spotted 1 warning sign for HengbaoLtd you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.