Why Investors Shouldn't Be Surprised By Redco Healthy Living Company Limited's (HKG:2370) 31% Share Price Surge

Despite an already strong run, Redco Healthy Living Company Limited (HKG:2370) shares have been powering on, with a gain of 31% in the last thirty days. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Following the firm bounce in price, Redco Healthy Living's price-to-earnings (or "P/E") ratio of 78.2x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 4x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

For example, consider that Redco Healthy Living's financial performance has been poor lately as it's earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Redco Healthy Living

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Redco Healthy Living will help you shine a light on its historical performance.

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

The only time you'd be truly comfortable seeing a P/E as steep as Redco Healthy Living's is when the company's growth is on track to outshine the market decidedly.

Retrospectively, the last year delivered a frustrating 19% decrease to the company's bottom line. Even so, admirably EPS has lifted 128% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Comparing that to the market, which is only predicted to deliver 15% growth in the next 12 months, the company's momentum is stronger based on recent medium-term annualised earnings results.

With this information, we can see why Redco Healthy Living is trading at such a high P/E compared to the market. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the bourse.

The Bottom Line On Redco Healthy Living's P/E

Redco Healthy Living's P/E is flying high just like its stock has during the last month. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Redco Healthy Living revealed its three-year earnings trends are contributing to its high P/E, given they look better than current market expectations. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. If recent medium-term earnings trends continue, it's hard to see the share price falling strongly in the near future under these circumstances.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Redco Healthy Living that you need to be mindful of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a P/E below 20x.

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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.