China Tobacco International (HK) Company Limited's (HKG:6055) 25% Share Price Surge Not Quite Adding Up

The China Tobacco International (HK) Company Limited (HKG:6055) share price has done very well over the last month, posting an excellent gain of 25%. Looking back a bit further, it's encouraging to see the stock is up 86% in the last year.

Since its price has surged higher, China Tobacco International (HK)'s price-to-earnings (or "P/E") ratio of 16.9x 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 5x 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.

Recent times have been advantageous for China Tobacco International (HK) 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.

See our latest analysis for China Tobacco International (HK)

Keen to find out how analysts think China Tobacco International (HK)'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 China Tobacco International (HK)'s to be considered reasonable.

Retrospectively, the last year delivered an exceptional 28% gain to the company's bottom line. As a result, it also grew EPS by 18% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 7.5% per annum during the coming three years according to the three analysts following the company. That's shaping up to be materially lower than the 13% per annum growth forecast for the broader market.

With this information, we find it concerning that China Tobacco International (HK) 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 Key Takeaway

The strong share price surge has got China Tobacco International (HK)'s P/E rushing to great heights as well. 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 Tobacco International (HK)'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. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You always need to take note of risks, for example - China Tobacco International (HK) has 1 warning sign we think you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.