With a price-to-earnings (or "P/E") ratio of 26.2x Xin Hwa Holdings Berhad (KLSE:XINHWA) may be sending very bearish signals at the moment, given that almost half of all companies in Malaysia have P/E ratios under 13x and even P/E's lower than 7x are not unusual. 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 Xin Hwa Holdings Berhad 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
View our latest analysis for Xin Hwa Holdings Berhad
Although there are no analyst estimates available for Xin Hwa Holdings Berhad, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
What Are Growth Metrics Telling Us About The High P/E?
In order to justify its P/E ratio, Xin Hwa Holdings Berhad would need to produce outstanding growth well in excess of the market.
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 30%. As a result, earnings from three years ago have also fallen 38% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
In contrast to the company, the rest of the market is expected to grow by 13% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
In light of this, it's alarming that Xin Hwa Holdings Berhad's P/E sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh heavily on the share price eventually.
The Key Takeaway
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.
Our examination of Xin Hwa Holdings Berhad revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. 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.