China Mengniu Dairy Company Limited's (HKG:2319) 26% Price Boost Is Out Of Tune With Earnings

China Mengniu Dairy Company Limited (HKG:2319) shares have had a really impressive month, gaining 26% after a shaky period beforehand. Notwithstanding the latest gain, the annual share price return of 4.3% isn't as impressive.

Since its price has surged higher, China Mengniu Dairy's price-to-earnings (or "P/E") ratio of 16.3x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 10x and even P/E's below 6x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

While the market has experienced earnings growth lately, China Mengniu Dairy's earnings have gone into reverse gear, which is not great. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for China Mengniu Dairy

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

Is There Enough Growth For China Mengniu Dairy?

In order to justify its P/E ratio, China Mengniu Dairy would need to produce outstanding growth well in excess of the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 7.0%. The last three years don't look nice either as the company has shrunk EPS by 19% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 11% per annum during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 13% each year growth forecast for the broader market.

With this information, we find it concerning that China Mengniu Dairy is trading at a P/E higher than the market. 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Key Takeaway

The strong share price surge has got China Mengniu Dairy's P/E rushing to great heights as well. 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 China Mengniu Dairy'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.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for China Mengniu Dairy with six simple checks on some of these key factors.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.