Tencent Holdings Limited's (HKG:700) Share Price Not Quite Adding Up

When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Tencent Holdings Limited (HKG:700) as a stock to potentially avoid with its 12.8x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times have been pleasing for Tencent Holdings as its earnings have risen in spite of the market's earnings going into reverse. The P/E is probably high because investors think the company will continue to navigate the broader market headwinds better than most. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Tencent Holdings

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

The only time you'd be truly comfortable seeing a P/E as high as Tencent Holdings' is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a decent 11% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 62% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 3.1% each year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 15% per year, which is noticeably more attractive.

In light of this, it's alarming that Tencent Holdings' P/E sits above the majority of other companies. 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 Final Word

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.

Our examination of Tencent Holdings' 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

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

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.