The Price Is Right For FIT Hon Teng Limited (HKG:6088)

FIT Hon Teng Limited's (HKG:6088) price-to-earnings (or "P/E") ratio of 34x 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 12x and even P/E's below 7x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.

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FIT Hon Teng 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. If not, then existing shareholders may be extremely nervous about the viability of the share price.

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Is There Enough Growth For FIT Hon Teng?

FIT Hon Teng'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, dishearteningly the company's profits fell to the tune of 10%. This means it has also seen a slide in earnings over the longer-term as EPS is down 31% in total over the last three years. 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 27% per year as estimated by the eight analysts watching the company. Meanwhile, the rest of the market is forecast to only expand by 14% per annum, which is noticeably less attractive.

In light of this, it's understandable that FIT Hon Teng's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

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 FIT Hon Teng 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. It's hard to see the share price falling strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with FIT Hon Teng, and understanding them should be part of your investment process.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.