More Unpleasant Surprises Could Be In Store For Arts Optical International Holdings Limited's (HKG:1120) Shares After Tumbling 27%

The Arts Optical International Holdings Limited (HKG:1120) share price has softened a substantial 27% over the previous 30 days, handing back much of the gains the stock has made lately. Looking at the bigger picture, even after this poor month the stock is up 48% in the last year.

In spite of the heavy fall in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 10x, you may still consider Arts Optical International Holdings as a stock to avoid entirely with its 15.5x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For instance, Arts Optical International Holdings' receding earnings in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, 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.

View our latest analysis for Arts Optical International Holdings

Although there are no analyst estimates available for Arts Optical International Holdings, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

What Are Growth Metrics Telling Us About The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Arts Optical International Holdings' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 70%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 21% shows it's noticeably less attractive on an annualised basis.

With this information, we find it concerning that Arts Optical International Holdings is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Even after such a strong price drop, Arts Optical International Holdings' P/E still exceeds the rest of the market significantly. 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 Arts Optical International Holdings currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. 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.

There are also other vital risk factors to consider and we've discovered 5 warning signs for Arts Optical International Holdings (2 are concerning!) that you should be aware of before investing here.

Of course, you might also be able to find a better stock than Arts Optical International Holdings. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.