There's Reason For Concern Over China Display Optoelectronics Technology Holdings Limited's (HKG:334) Massive 31% Price Jump

China Display Optoelectronics Technology Holdings Limited (HKG:334) shareholders are no doubt pleased to see that the share price has bounced 31% in the last month, although it is still struggling to make up recently lost ground. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 4.5% in the last twelve months.

Following the firm bounce in price, China Display Optoelectronics Technology Holdings' price-to-earnings (or "P/E") ratio of 14.5x 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. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For example, consider that China Display Optoelectronics Technology Holdings' financial performance has been pretty ordinary lately as earnings growth is non-existent. It might be that many are expecting an improvement to the uninspiring earnings performance over the coming period, which has kept the P/E from collapsing. If not, then existing shareholders may be a little nervous about the viability of the share price.

See our latest analysis for China Display Optoelectronics Technology Holdings

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on China Display Optoelectronics Technology Holdings will help you shine a light on its historical performance.

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 Display Optoelectronics Technology Holdings' to be considered reasonable.

Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. The lack of growth did nothing to help the company's aggregate three-year performance, which is an unsavory 62% drop in EPS. 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 22% shows it's an unpleasant look.

In light of this, it's alarming that China Display Optoelectronics Technology Holdings' 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. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

The strong share price surge has got China Display Optoelectronics Technology Holdings' 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 Display Optoelectronics Technology Holdings 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.

You need to take note of risks, for example - China Display Optoelectronics Technology Holdings has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

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 low P/E.

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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.