Sprocomm Intelligence Limited's (HKG:1401) Popularity With Investors Under Threat As Stock Sinks 26%

Sprocomm Intelligence Limited (HKG:1401) shareholders won't be pleased to see that the share price has had a very rough month, dropping 26% and undoing the prior period's positive performance. For any long-term shareholders, the last month ends a year to forget by locking in a 65% share price decline.

In spite of the heavy fall in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 11x, you may still consider Sprocomm Intelligence as a stock to avoid entirely with its 56.5x 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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For example, consider that Sprocomm Intelligence's financial performance has been poor lately as its earnings have been in decline. 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 Sprocomm Intelligence

Does Growth Match The High P/E?

In order to justify its P/E ratio, Sprocomm Intelligence 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 50%. Unfortunately, that's brought it right back to where it started three years ago with EPS growth being virtually non-existent overall during that time. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Comparing that to the market, which is predicted to deliver 19% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

In light of this, it's alarming that Sprocomm Intelligence's 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.

What We Can Learn From Sprocomm Intelligence's P/E?

A significant share price dive has done very little to deflate Sprocomm Intelligence's very lofty 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.

Our examination of Sprocomm Intelligence revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Before you settle on your opinion, we've discovered 4 warning signs for Sprocomm Intelligence (1 can't be ignored!) that you should be aware of.

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