Investors Appear Satisfied With Tencent Holdings Limited's (HKG:700) Prospects As Shares Rocket 27%

Tencent Holdings Limited (HKG:700) shareholders have had their patience rewarded with a 27% share price jump in the last month. The last 30 days bring the annual gain to a very sharp 81%.

After such a large jump in price, Tencent Holdings may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 24.9x, since almost half of all companies in Hong Kong have P/E ratios under 10x and even P/E's lower than 6x are not unusual. 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.

Tencent Holdings hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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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 Tencent Holdings' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 11%. The last three years don't look nice either as the company has shrunk EPS by 5.4% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 18% each year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 12% per year, which is noticeably less attractive.

With this information, we can see why Tencent Holdings is trading at such a high P/E compared to the market. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Bottom Line On Tencent Holdings' P/E

Tencent Holdings' P/E is flying high just like its stock has during the last month. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Tencent Holdings' analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Tencent Holdings with six simple checks will allow you to discover any risks that could be an issue.

If these risks are making you reconsider your opinion on Tencent Holdings, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.