Hong Kong Exchanges and Clearing Limited's (HKG:388) Popularity With Investors Is Under Threat From Overpricing

When close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 11x, you may consider Hong Kong Exchanges and Clearing Limited (HKG:388) as a stock to avoid entirely with its 38x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

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With earnings growth that's superior to most other companies of late, Hong Kong Exchanges and Clearing has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Hong Kong Exchanges and Clearing

Does Growth Match The High P/E?

There's an inherent assumption that a company should far outperform the market for P/E ratios like Hong Kong Exchanges and Clearing's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 24% last year. As a result, it also grew EPS by 25% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 6.7% each year over the next three years. Meanwhile, the rest of the market is forecast to expand by 15% each year, which is noticeably more attractive.

With this information, we find it concerning that Hong Kong Exchanges and Clearing is trading at a P/E higher than the market. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of earnings growth is likely to weigh heavily on the share price eventually.

What We Can Learn From Hong Kong Exchanges and Clearing's 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 Hong Kong Exchanges and Clearing currently trades on a much higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the high P/E lower. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Hong Kong Exchanges and Clearing with six simple checks will allow you to discover any risks that could be an issue.

You might be able to find a better investment than Hong Kong Exchanges and Clearing. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.