Deep Source Holdings Limited's (HKG:990) Popularity With Investors Under Threat As Stock Sinks 31%

Deep Source Holdings Limited (HKG:990) shares have had a horrible month, losing 31% after a relatively good period beforehand. Looking at the bigger picture, even after this poor month the stock is up 69% in the last year.

Even after such a large drop in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 12x, you may still consider Deep Source Holdings as a stock to avoid entirely with its 29.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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For instance, Deep Source Holdings' 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 Deep Source Holdings

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 Deep Source Holdings' earnings, revenue and cash flow.

How Is Deep Source Holdings' Growth Trending?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Deep Source Holdings' to be considered reasonable.

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 51%. The last three years don't look nice either as the company has shrunk EPS by 71% 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 20% 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 Deep Source Holdings' P/E sits above the majority of other companies. 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 Key Takeaway

A significant share price dive has done very little to deflate Deep Source Holdings' very lofty P/E. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Deep Source Holdings revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. 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.

You should always think about risks. Case in point, we've spotted 1 warning sign for Deep Source Holdings you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.