China Mengniu Dairy Company Limited's (HKG:2319) Shares May Have Run Too Fast Too Soon

When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 8x, you may consider China Mengniu Dairy Company Limited (HKG:2319) as a stock to avoid entirely with its 15.4x 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 so lofty.

China Mengniu Dairy could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for China Mengniu Dairy

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Does Growth Match The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 22%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 41% in total over the last three years. 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 16% per annum over the next three years. Meanwhile, the rest of the market is forecast to expand by 15% per year, which is not materially different.

In light of this, it's curious that China Mengniu Dairy's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

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.

We've established that China Mengniu Dairy currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Before you settle on your opinion, we've discovered 1 warning sign for China Mengniu Dairy that you should be aware of.

You might be able to find a better investment than China Mengniu Dairy. 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.