NetEase Cloud Music Inc.'s (HKG:9899) Shares Climb 25% But Its Business Is Yet to Catch Up

NetEase Cloud Music Inc. (HKG:9899) shareholders have had their patience rewarded with a 25% share price jump in the last month. Looking back a bit further, it's encouraging to see the stock is up 84% in the last year.

Since its price has surged higher, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 10x, you may consider NetEase Cloud Music as a stock to avoid entirely with its 21.1x P/E ratio. 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 growth that's superior to most other companies of late, NetEase Cloud Music has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for NetEase Cloud Music

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

Is There Enough Growth For NetEase Cloud Music?

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

If we review the last year of earnings growth, the company posted a terrific increase of 114%. Still, EPS has barely risen at all from three years ago in total, which is not ideal. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 8.5% per year as estimated by the eleven analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 12% each year, which is noticeably more attractive.

With this information, we find it concerning that NetEase Cloud Music is trading at a P/E higher than the market. 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. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Bottom Line On NetEase Cloud Music's P/E

NetEase Cloud Music's 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.

Our examination of NetEase Cloud Music's analyst forecasts revealed that its inferior earnings outlook isn't impacting its high P/E anywhere near as much as we would have predicted. 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for NetEase Cloud Music with six simple checks.

You might be able to find a better investment than NetEase Cloud Music. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.