What Guangdong Green Precision Components Co., Ltd's (SZSE:300968) 25% Share Price Gain Is Not Telling You

Guangdong Green Precision Components Co., Ltd (SZSE:300968) shareholders are no doubt pleased to see that the share price has bounced 25% in the last month, although it is still struggling to make up recently lost ground. Notwithstanding the latest gain, the annual share price return of 3.2% isn't as impressive.

After such a large jump in price, Guangdong Green Precision Components' price-to-earnings (or "P/E") ratio of 58.2x might make it look like a strong sell right now compared to the market in China, where around half of the companies have P/E ratios below 30x and even P/E's below 18x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

For example, consider that Guangdong Green Precision Components' financial performance has been poor lately as its earnings have been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/E from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

See our latest analysis for Guangdong Green Precision Components

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Guangdong Green Precision Components' earnings, revenue and cash flow.

How Is Guangdong Green Precision Components' Growth Trending?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Guangdong Green Precision Components' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 47% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 65% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

In contrast to the company, the rest of the market is expected to grow by 41% 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 Guangdong Green Precision Components' 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 Key Takeaway

Shares in Guangdong Green Precision Components have built up some good momentum lately, which has really inflated its P/E. 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 Guangdong Green Precision Components 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.

You need to take note of risks, for example - Guangdong Green Precision Components has 3 warning signs (and 2 which are significant) we think you should know about.

If these risks are making you reconsider your opinion on Guangdong Green Precision Components, 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.