Shanghai Shentong Metro Co.,Ltd.'s (SHSE:600834) Shares Climb 30% But Its Business Is Yet to Catch Up

Shanghai Shentong Metro Co.,Ltd. (SHSE:600834) shareholders would be excited to see that the share price has had a great month, posting a 30% gain and recovering from prior weakness. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

After such a large jump in price, Shanghai Shentong MetroLtd's price-to-earnings (or "P/E") ratio of 61.4x 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 27x and even P/E's below 16x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, Shanghai Shentong MetroLtd'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.

See our latest analysis for Shanghai Shentong MetroLtd

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 Shanghai Shentong MetroLtd'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 steep as Shanghai Shentong MetroLtd's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 13%. As a result, earnings from three years ago have also fallen 2.7% overall. 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 36% 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 Shanghai Shentong MetroLtd 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. 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

Shares in Shanghai Shentong MetroLtd have built up some good momentum lately, which has really inflated its P/E. 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 Shanghai Shentong MetroLtd currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Shanghai Shentong MetroLtd with six simple checks.

If these risks are making you reconsider your opinion on Shanghai Shentong MetroLtd, 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com