Cloud Music Inc.'s (HKG:9899) 28% Price Boost Is Out Of Tune With Earnings

Cloud Music Inc. (HKG:9899) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 43% in the last year.

Following the firm bounce in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Cloud Music as a stock to avoid entirely with its 18.9x P/E ratio. 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.

Cloud Music certainly has been doing a good job lately as it's been growing earnings more than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Cloud Music

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Cloud Music.

Is There Enough Growth For Cloud Music?

Cloud Music's 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.

Retrospectively, the last year delivered an exceptional 267% gain to the company's bottom line. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Shifting to the future, estimates from the eleven analysts covering the company suggest earnings should grow by 7.1% per annum over the next three years. With the market predicted to deliver 12% growth per annum, the company is positioned for a weaker earnings result.

With this information, we find it concerning that Cloud Music is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. 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.

What We Can Learn From Cloud Music's P/E?

Shares in Cloud Music have built up some good momentum lately, which has really inflated its P/E. 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 Cloud Music currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Cloud Music with six simple checks will allow you to discover any risks that could be an issue.

If you're unsure about the strength of Cloud Music's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.