Chongqing Machinery & Electric Co., Ltd. (HKG:2722) Soars 26% But It's A Story Of Risk Vs Reward

The Chongqing Machinery & Electric Co., Ltd. (HKG:2722) share price has done very well over the last month, posting an excellent gain of 26%. Taking a wider view, although not as strong as the last month, the full year gain of 21% is also fairly reasonable.

In spite of the firm bounce in price, Chongqing Machinery & Electric's price-to-earnings (or "P/E") ratio of 5.8x might still make it look like a buy right now compared to the market in Hong Kong, where around half of the companies have P/E ratios above 10x and even P/E's above 20x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Chongqing Machinery & Electric has been doing a good job lately as it's been growing earnings at a solid pace. It might be that many expect the respectable earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be optimistic about the future direction of the share price.

Check out our latest analysis for Chongqing Machinery & Electric

Although there are no analyst estimates available for Chongqing Machinery & Electric, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

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

In order to justify its P/E ratio, Chongqing Machinery & Electric would need to produce sluggish growth that's trailing the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 25% last year. The strong recent performance means it was also able to grow EPS by 79% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 22% shows it's about the same on an annualised basis.

With this information, we find it odd that Chongqing Machinery & Electric is trading at a P/E lower than the market. It may be that most investors are not convinced the company can maintain recent growth rates.

What We Can Learn From Chongqing Machinery & Electric's P/E?

Despite Chongqing Machinery & Electric's shares building up a head of steam, its P/E still lags most other companies. 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.

Our examination of Chongqing Machinery & Electric revealed its three-year earnings trends aren't contributing to its P/E as much as we would have predicted, given they look similar to current market expectations. When we see average earnings with market-like growth, we assume potential risks are what might be placing pressure on the P/E ratio. It appears some are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions should normally provide more support to the share price.

It is also worth noting that we have found 2 warning signs for Chongqing Machinery & Electric that you need to take into consideration.

If you're unsure about the strength of Chongqing Machinery & Electric's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.