Earnings Not Telling The Story For Guangzhou Devotion Thermal Technology Co., Ltd. (SZSE:300335) After Shares Rise 38%

The Guangzhou Devotion Thermal Technology Co., Ltd. (SZSE:300335) share price has done very well over the last month, posting an excellent gain of 38%. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 4.0% over the last year.

After such a large jump in price, Guangzhou Devotion Thermal Technology's price-to-earnings (or "P/E") ratio of 44x might make it look like a sell right now compared to the market in China, where around half of the companies have P/E ratios below 33x and even P/E's below 20x are quite common. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For instance, Guangzhou Devotion Thermal Technology's receding earnings in recent times would have to be some food for thought. 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.

Check out our latest analysis for Guangzhou Devotion Thermal Technology

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Guangzhou Devotion Thermal Technology will help you shine a light on its historical performance.

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

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 46%. The last three years don't look nice either as the company has shrunk EPS by 6.2% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 37% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Guangzhou Devotion Thermal 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. 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.

The Bottom Line On Guangzhou Devotion Thermal Technology's P/E

Guangzhou Devotion Thermal Technology shares have received a push in the right direction, but its P/E is elevated too. 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.

We've established that Guangzhou Devotion Thermal Technology 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.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Guangzhou Devotion Thermal Technology (of which 1 doesn't sit too well with us!) you should know about.

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.