Old Chang Kee Ltd.'s (Catalist:5ML) price-to-earnings (or "P/E") ratio of 17x might make it look like a strong sell right now compared to the market in Singapore, where around half of the companies have P/E ratios below 10x and even P/E's below 5x are quite common. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.
As an illustration, earnings have deteriorated at Old Chang Kee over the last year, which is not ideal at all. One possibility is that the P/E is high because investors think the company will still do enough to outperform the broader market in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.
See our latest analysis for Old Chang Kee
We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Old Chang Kee's earnings, revenue and cash flow.
What Are Growth Metrics Telling Us About The High P/E?
There's an inherent assumption that a company should far outperform the market for P/E ratios like Old Chang Kee's to be considered reasonable.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 17%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 36% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.
In contrast to the company, the rest of the market is expected to decline by 1.0% over the next year, which puts the company's recent medium-term positive growth rates in a good light for now.
With this information, we can see why Old Chang Kee is trading at a high P/E compared to the market. Investors are willing to pay more for a stock they hope will buck the trend of the broader market going backwards. Nonetheless, with most other businesses facing an uphill battle, staying on its current earnings path is no certainty.
The Final Word
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 Old Chang Kee maintains its high P/E on the strength of its recentthree-year growth beating forecasts for a struggling market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident earnings aren't under threat. Our only concern is whether its earnings trajectory can keep outperforming under these tough market conditions. Although, if the company's relative performance doesn't change it will continue to provide strong support to the share price.