China Wan Tong Yuan (Holdings) Limited's (HKG:6966) 31% Price Boost Is Out Of Tune With Earnings

China Wan Tong Yuan (Holdings) Limited (HKG:6966) shares have had a really impressive month, gaining 31% after a shaky period beforehand. Taking a wider view, although not as strong as the last month, the full year gain of 22% is also fairly reasonable.

Since its price has surged higher, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 11x, you may consider China Wan Tong Yuan (Holdings) as a stock to avoid entirely with its 54.8x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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For example, consider that China Wan Tong Yuan (Holdings)'s financial performance has been poor lately as its earnings have been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for China Wan Tong Yuan (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 China Wan Tong Yuan (Holdings)'s earnings, revenue and cash flow.

Does Growth Match The High P/E?

In order to justify its P/E ratio, China Wan Tong Yuan (Holdings) would need to produce outstanding growth well in excess of 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 44%. The last three years don't look nice either as the company has shrunk EPS by 46% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 21% 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 China Wan Tong Yuan (Holdings)'s P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Final Word

The strong share price surge has got China Wan Tong Yuan (Holdings)'s P/E rushing to great heights as well. 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 Wan Tong Yuan (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. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with China Wan Tong Yuan (Holdings) (at least 1 which is concerning), and understanding them should be part of your investment process.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.