Some Shareholders Feeling Restless Over Nongfu Spring Co., Ltd.'s (HKG:9633) P/E Ratio

With a price-to-earnings (or "P/E") ratio of 41.1x Nongfu Spring Co., Ltd. (HKG:9633) may be sending very bearish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios under 9x and even P/E's lower than 5x are not unusual. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Nongfu Spring certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.

Check out 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.

If we review the last year of earnings growth, the company posted a terrific increase of 42%. The strong recent performance means it was also able to grow EPS by 123% 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.

Turning to the outlook, the next three years should generate growth of 13% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 16% per year, 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. 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 Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Nongfu Spring currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. 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. 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. Our free balance sheet analysis for Nongfu Spring with six simple checks will allow you to discover any risks that could be an issue.

You might be able to find a better investment than Nongfu Spring. 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.