Investors Still Waiting For A Pull Back In China Literature Limited (HKG:772)

With a price-to-earnings (or "P/E") ratio of 35.3x China Literature Limited (HKG:772) 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 4x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

With earnings that are retreating more than the market's of late, China Literature has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.

Check out our latest analysis for China Literature

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Is There Enough Growth For China Literature?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 24%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Turning to the outlook, the next three years should generate growth of 27% each year as estimated by the analysts watching the company. That's shaping up to be materially higher than the 16% per year growth forecast for the broader market.

With this information, we can see why China Literature 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.

What We Can Learn From China Literature's P/E?

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 China Literature maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for China Literature that you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.