More Unpleasant Surprises Could Be In Store For Hengbao Co.,Ltd.'s (SZSE:002104) Shares After Tumbling 26%

Hengbao Co.,Ltd. (SZSE:002104) shares have had a horrible month, losing 26% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 14% share price drop.

In spite of the heavy fall in price, given around half the companies in China have price-to-earnings ratios (or "P/E's") below 32x, you may still consider HengbaoLtd as a stock to potentially avoid with its 38.7x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For instance, HengbaoLtd's receding earnings in recent times would have to be some food for thought. 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.

What Are Growth Metrics Telling Us About The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as HengbaoLtd's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a frustrating 25% decrease to the company's bottom line. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 38% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that HengbaoLtd's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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.

What We Can Learn From HengbaoLtd's P/E?

Despite the recent share price weakness, HengbaoLtd's P/E remains higher than most other companies. 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.

Our examination of HengbaoLtd revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

We don't want to rain on the parade too much, but we did also find 1 warning sign for HengbaoLtd that you need to be mindful of.

You might be able to find a better investment than HengbaoLtd. 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.