Tak Lee Machinery Holdings Limited's (HKG:2102) price-to-earnings (or "P/E") ratio of 19.6x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 12x and even P/E's below 7x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Earnings have risen firmly for Tak Lee Machinery Holdings recently, which is pleasing to see. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
See our latest analysis for Tak Lee Machinery Holdings
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Tak Lee Machinery Holdings would need to produce outstanding growth well in excess of the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 24% last year. However, this wasn't enough as the latest three year period has seen a very unpleasant 68% drop in EPS in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 20% shows it's an unpleasant look.
With this information, we find it concerning that Tak Lee Machinery Holdings 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. 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 Tak Lee Machinery Holdings' P/E
While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.
We've established that Tak Lee Machinery Holdings 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.
You need to take note of risks, for example - Tak Lee Machinery Holdings has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
If these risks are making you reconsider your opinion on Tak Lee Machinery Holdings, 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.