There's Reason For Concern Over China Telecom Corporation Limited's (HKG:728) Price

When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider China Telecom Corporation Limited (HKG:728) as a stock to potentially avoid with its 11.7x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

China Telecom certainly has been doing a good job lately as it's been growing earnings more than most other companies. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

See 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 impressive growth in excess of the market.

Retrospectively, the last year delivered a decent 9.5% gain to the company's bottom line. The latest three year period has also seen a 27% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 8.2% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 16% per year, which is noticeably more attractive.

In light of this, it's alarming that China Telecom's P/E sits above the majority of other companies. 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 Final Word

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

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. 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. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Plus, you should also learn about this 1 warning sign we've spotted with China Telecom.

If these risks are making you reconsider your opinion on China Telecom, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

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