China Telecom Corporation Limited's (HKG:728) Shares Climb 28% But Its Business Is Yet to Catch Up

Despite an already strong run, China Telecom Corporation Limited (HKG:728) shares have been powering on, with a gain of 28% in the last thirty days. The last 30 days bring the annual gain to a very sharp 53%.

Since its price has surged higher, China Telecom's price-to-earnings (or "P/E") ratio of 16.2x 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 10x and even P/E's below 6x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Recent times have been advantageous for China Telecom 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. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for China Telecom

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

In order to justify its P/E ratio, China Telecom would need to produce outstanding growth well in excess of the market.

Retrospectively, the last year delivered a decent 6.7% gain to the company's bottom line. The solid recent performance means it was also able to grow EPS by 16% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Looking ahead now, EPS is anticipated to climb by 8.2% each year during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 13% each year growth forecast for the broader market.

With this information, we find it concerning that China Telecom is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

Shares in China Telecom have built up some good momentum lately, which has really inflated its P/E. 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.

We've established that China Telecom currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. Right now we are increasingly uncomfortable with the high P/E as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you take the next step, you should know about the 1 warning sign for China Telecom that we have uncovered.

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).

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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.