Cheng Loong Corporation's (TWSE:1904) Share Price Could Signal Some Risk

With a price-to-earnings (or "P/E") ratio of 25.9x Cheng Loong Corporation (TWSE:1904) may be sending bearish signals at the moment, given that almost half of all companies in Taiwan have P/E ratios under 21x and even P/E's lower than 15x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

Cheng Loong has been doing a good job lately as it's been growing earnings at a solid pace. It might be that many expect the respectable earnings performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Cheng Loong

Although there are no analyst estimates available for Cheng Loong, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Cheng Loong's Growth Trending?

There's an inherent assumption that a company should outperform the market for P/E ratios like Cheng Loong's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 19%. However, this wasn't enough as the latest three year period has seen a very unpleasant 77% drop in EPS in aggregate. 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 24% shows it's an unpleasant look.

With this information, we find it concerning that Cheng Loong is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

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 Cheng Loong currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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. 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.

Plus, you should also learn about these 3 warning signs we've spotted with Cheng Loong (including 2 which are a bit unpleasant).

You might be able to find a better investment than Cheng Loong. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.