NetEase, Inc.'s (HKG:9999) Price Is Out Of Tune With Earnings

When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 12x, you may consider NetEase, Inc. (HKG:9999) as a stock to potentially avoid with its 17.9x P/E ratio. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

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With earnings growth that's superior to most other companies of late, NetEase has been doing relatively well. It seems that many are expecting the strong earnings performance to persist, which has raised the P/E. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for NetEase

Keen to find out how analysts think NetEase's future stacks up against the industry? In that case, our free report is a great place to start.

What Are Growth Metrics Telling Us About The High P/E?

In order to justify its P/E ratio, NetEase would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 33%. Pleasingly, EPS has also lifted 75% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 8.7% per year as estimated by the analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 14% per annum, which is noticeably more attractive.

With this information, we find it concerning that NetEase is trading at a P/E higher than the market. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

The Final Word

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that NetEase currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for NetEase with six simple checks will allow you to discover any risks that could be an issue.

Of course, you might also be able to find a better stock than NetEase. 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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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.