China Chengtong Development Group Limited's (HKG:217) 31% Share Price Surge Not Quite Adding Up

China Chengtong Development Group Limited (HKG:217) shareholders would be excited to see that the share price has had a great month, posting a 31% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 34% in the last year.

After such a large jump in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 11x, you may consider China Chengtong Development Group as a stock to avoid entirely with its 17.8x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

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As an illustration, earnings have deteriorated at China Chengtong Development Group over the last year, which is not ideal at all. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

View our latest analysis for China Chengtong Development Group

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 China Chengtong Development Group's earnings, revenue and cash flow.

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

China Chengtong Development Group's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than 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 43%. This means it has also seen a slide in earnings over the longer-term as EPS is down 64% in total over the last three years. 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 19% 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 China Chengtong Development Group is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Key Takeaway

Shares in China Chengtong Development Group have built up some good momentum lately, which has really inflated its P/E. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that China Chengtong Development Group 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.

Before you take the next step, you should know about the 3 warning signs for China Chengtong Development Group (1 can't be ignored!) that we have uncovered.

Of course, you might also be able to find a better stock than China Chengtong Development Group. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.