Li Ning Company Limited's (HKG:2331) 30% Share Price Surge Not Quite Adding Up

Li Ning Company Limited (HKG:2331) shareholders are no doubt pleased to see that the share price has bounced 30% in the last month, although it is still struggling to make up recently lost ground. Still, the 30-day jump doesn't change the fact that longer term shareholders have seen their stock decimated by the 70% share price drop in the last twelve months.

Since its price has surged higher, given around half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 8x, you may consider Li Ning as a stock to potentially avoid with its 12.5x 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 as high as it is.

Recent times haven't been advantageous for Li Ning as its earnings have been falling quicker than most other companies. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

See our latest analysis for Li Ning

Want the full picture on analyst estimates for the company? Then our free report on Li Ning will help you uncover what's on the horizon.

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

There's an inherent assumption that a company should outperform the market for P/E ratios like Li Ning's 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 7.6%. Still, the latest three year period has seen an excellent 172% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 8.5% per annum over the next three years. That's shaping up to be materially lower than the 16% per year growth forecast for the broader market.

In light of this, it's alarming that Li Ning's P/E sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Li Ning's P/E

Li Ning's P/E is getting right up there since its shares have risen strongly. 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 Li Ning's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Li Ning that you need to be mindful of.

You might be able to find a better investment than Li Ning. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.