NetEase, Inc.'s (HKG:9999) 26% Share Price Surge Not Quite Adding Up

NetEase, Inc. (HKG:9999) shareholders have had their patience rewarded with a 26% share price jump in the last month. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 8.2% in the last twelve months.

Since its price has surged higher, NetEase may be sending very bearish signals at the moment with a price-to-earnings (or "P/E") ratio of 16.5x, since almost half of all companies in Hong Kong have P/E ratios under 9x and even P/E's lower than 5x 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.

Recent times have been advantageous for NetEase as its earnings have been rising faster 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.

View our latest analysis for NetEase

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

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 NetEase's to be considered reasonable.

If we review the last year of earnings growth, the company posted a worthy increase of 3.1%. Pleasingly, EPS has also lifted 135% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 11% per year over the next three years. That's shaping up to be similar to the 12% per year growth forecast for the broader market.

In light of this, it's curious that NetEase's P/E sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Final Word

NetEase's P/E is flying high just like its stock has during the last month. 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 NetEase currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for NetEase that you should be aware of.

You might be able to find a better investment than NetEase. 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.