Some Confidence Is Lacking In China New Town Development Company Limited's (HKG:1278) P/E

With a price-to-earnings (or "P/E") ratio of 13.7x China New Town Development Company Limited (HKG:1278) may be sending bearish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios under 10x and even P/E's lower than 6x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

For instance, China New Town Development's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for China New Town Development

Although there are no analyst estimates available for China New Town Development, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

What Are Growth Metrics Telling Us About The High P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 69%. As a result, earnings from three years ago have also fallen 59% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 20% shows it's an unpleasant look.

In light of this, it's alarming that China New Town Development's P/E sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

What We Can Learn From China New Town Development'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.

Our examination of China New Town Development revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

We don't want to rain on the parade too much, but we did also find 4 warning signs for China New Town Development that you need to be mindful of.

You might be able to find a better investment than China New Town Development. 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.