When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Hong Kong Exchanges and Clearing Limited (HKG:388) as a stock to avoid entirely with its 33.7x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

Hong Kong Exchanges and Clearing could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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Is There Enough Growth For Hong Kong Exchanges and Clearing?

Hong Kong Exchanges and Clearing'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.

Retrospectively, the last year delivered a frustrating 3.0% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 7.1% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 13% each year as estimated by the analysts watching the company. With the market predicted to deliver 12% growth per year, the company is positioned for a comparable earnings result.

With this information, we find it interesting that Hong Kong Exchanges and Clearing is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On Hong Kong Exchanges and Clearing's P/E

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Hong Kong Exchanges and Clearing currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Hong Kong Exchanges and Clearing with six simple checks.

If you're unsure about the strength of Hong Kong Exchanges and Clearing's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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