There's Reason For Concern Over Hannong Chemicals Inc.'s (KRX:011500) Massive 38% Price Jump

The Hannong Chemicals Inc. (KRX:011500) share price has done very well over the last month, posting an excellent gain of 38%. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 3.3% over the last year.

After such a large jump in price, given close to half the companies in Korea have price-to-earnings ratios (or "P/E's") below 11x, you may consider Hannong Chemicals as a stock to avoid entirely with its 52.1x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For instance, Hannong Chemicals' receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for Hannong Chemicals

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Hannong Chemicals 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 Hannong Chemicals' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 40%. As a result, earnings from three years ago have also fallen 72% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 26% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we find it concerning that Hannong Chemicals is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

What We Can Learn From Hannong Chemicals' P/E?

Shares in Hannong Chemicals have built up some good momentum lately, which has really inflated its P/E. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Hannong Chemicals 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. Right now we are increasingly uncomfortable with the high P/E as this earnings performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Hannong Chemicals (1 can't be ignored!) that you need to be mindful of.

Of course, you might also be able to find a better stock than Hannong Chemicals. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.