Hongli Group Inc.'s (NASDAQ:HLP) 51% Share Price Surge Not Quite Adding Up

Hongli Group Inc. (NASDAQ:HLP) shareholders are no doubt pleased to see that the share price has bounced 51% in the last month, although it is still struggling to make up recently lost ground. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 33% in the last twelve months.

Since its price has surged higher, Hongli Group's price-to-earnings (or "P/E") ratio of 25.3x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

For instance, Hongli Group's 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Hongli Group

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

Is There Enough Growth For Hongli Group?

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

Retrospectively, the last year delivered a frustrating 75% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 71% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 12% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's alarming that Hongli Group's 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. 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 Final Word

Hongli Group shares have received a push in the right direction, but its P/E is elevated too. 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.

We've established that Hongli Group currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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.

Before you settle on your opinion, we've discovered 5 warning signs for Hongli Group (1 is a bit concerning!) that you should be aware of.

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.