China Literature Limited's (HKG:772) price-to-earnings (or "P/E") ratio of 25.4x might make it look like a strong sell right now compared to the market in Hong Kong, where around half of the companies have P/E ratios below 9x and even P/E's below 5x are quite common. 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.
Recent times have been advantageous for China Literature as its earnings have been rising faster than most other companies. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. If not, then existing shareholders might be a little nervous about the viability of the share price.
See our latest analysis for China Literature
China Literature's P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
If we review the last year of earnings growth, the company posted a terrific increase of 23%. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.
Looking ahead now, EPS is anticipated to climb by 19% each year during the coming three years according to the analysts following the company. That's shaping up to be materially higher than the 13% per year growth forecast for the broader market.
In light of this, it's understandable that China Literature'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.
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.
We've established that China Literature 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.
The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for China Literature with six simple checks on some of these key factors.
Of course, you might also be able to find a better stock than China Literature. 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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