When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Meitu, Inc. (HKG:1357) as a stock to avoid entirely with its 26.6x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Meitu hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It might be that many expect the dour earnings performance to recover substantially, 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.

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Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Meitu's is when the company's growth is on track to outshine the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 24%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Looking ahead now, EPS is anticipated to climb by 33% each year during the coming three years according to the seven analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 13% each year, which is noticeably less attractive.

In light of this, it's understandable that Meitu's P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

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 Meitu maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Meitu that you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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