Earnings Not Telling The Story For Success Dragon International Holdings Limited (HKG:1182) After Shares Rise 41%

Success Dragon International Holdings Limited (HKG:1182) shares have had a really impressive month, gaining 41% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 71% in the last year.

Since its price has surged higher, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 12x, you may consider Success Dragon International Holdings as a stock to avoid entirely with its 24x P/E ratio. 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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With earnings growth that's exceedingly strong of late, Success Dragon International Holdings has been doing very well. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for Success Dragon International Holdings

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

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

Taking a look back first, we see that the company grew earnings per share by an impressive 38% last year. The strong recent performance means it was also able to grow EPS by 32% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 21% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Success Dragon International Holdings' P/E sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

Shares in Success Dragon International Holdings have built up some good momentum lately, which has really inflated its P/E. 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 Success Dragon International Holdings currently trades on a much higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are increasingly uncomfortable with the high P/E as this earnings performance isn't likely to support such positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you take the next step, you should know about the 3 warning signs for Success Dragon International Holdings (1 is a bit concerning!) that we have uncovered.

If these risks are making you reconsider your opinion on Success Dragon International Holdings, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.