Unpleasant Surprises Could Be In Store For Luye Pharma Group Ltd.'s (HKG:2186) Shares

With a price-to-earnings (or "P/E") ratio of 13.6x Luye Pharma Group Ltd. (HKG:2186) may be sending 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 5x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Luye Pharma Group certainly has been doing a good job lately as it's been growing earnings more than most other companies. 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.

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Does Growth Match The High P/E?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 61% last year. As a result, it also grew EPS by 22% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 14% each year as estimated by the four analysts watching the company. That's shaping up to be similar to the 12% per annum growth forecast for the broader market.

In light of this, it's curious that Luye Pharma Group'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 Key Takeaway

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Luye Pharma Group's analyst forecasts revealed that its market-matching earnings outlook isn't impacting its high P/E as much as we would have predicted. When we see an average earnings outlook with market-like growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

A lot of potential risks can sit within a company's balance sheet. Take a look at our free balance sheet analysis for Luye Pharma Group with six simple checks on some of these key factors.

Of course, you might also be able to find a better stock than Luye Pharma Group. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.