After Leaping 30% Tencent Holdings Limited (HKG:700) Shares Are Not Flying Under The Radar

Tencent Holdings Limited (HKG:700) shares have continued their recent momentum with a 30% gain in the last month alone. Looking further back, the 16% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

After such a large jump in price, Tencent Holdings' price-to-earnings (or "P/E") ratio of 25.9x 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 9x and even P/E's below 5x 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, Tencent Holdings' earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Check out our latest analysis for Tencent Holdings

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

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

Tencent Holdings' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 30%. As a result, earnings from three years ago have also fallen 25% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 22% per year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 16% per annum growth forecast for the broader market.

In light of this, it's understandable that Tencent Holdings' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Key Takeaway

The strong share price surge has got Tencent Holdings' P/E rushing to great heights as well. 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 Tencent Holdings maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 1 warning sign for Tencent Holdings you should be aware of.

Of course, you might also be able to find a better stock than Tencent 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.