Nongfu Spring Co., Ltd.'s (HKG:9633) 29% Share Price Plunge Could Signal Some Risk

Nongfu Spring Co., Ltd. (HKG:9633) shares have had a horrible month, losing 29% after a relatively good period beforehand. Longer-term shareholders will rue the drop in the share price, since it's now virtually flat for the year after a promising few quarters.

In spite of the heavy fall in price, Nongfu Spring's price-to-earnings (or "P/E") ratio of 73.7x might still 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 11x and even P/E's below 6x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

Nongfu Spring certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Nongfu Spring

Keen to find out how analysts think Nongfu Spring's future stacks up against the industry? In that case, our free report is a great place to start.

How Is Nongfu Spring's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as steep as Nongfu Spring's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered an exceptional 15% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 46% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 18% per year over the next three years. Meanwhile, the rest of the market is forecast to expand by 22% per annum, which is noticeably more attractive.

With this information, we find it concerning that Nongfu Spring is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. 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 Key Takeaway

Nongfu Spring's shares may have retreated, but its P/E is still flying high. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Nongfu Spring'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. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

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

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.

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This article by Simply Wall St is general in nature. 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.
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