Some Shareholders Feeling Restless Over NetEase, Inc.'s (HKG:9999) P/E Ratio

With a price-to-earnings (or "P/E") ratio of 18x NetEase, Inc. (HKG:9999) may be sending bearish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios under 12x and even P/E's lower than 7x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

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With earnings growth that's superior to most other companies of late, NetEase has been doing relatively well. The P/E is probably high because investors think this strong earnings performance will continue. If not, then existing shareholders might be a little nervous about the viability of the share price.

View our latest analysis for NetEase

Does Growth Match The High P/E?

In order to justify its P/E ratio, NetEase would need to produce impressive growth in excess of the market.

If we review the last year of earnings growth, the company posted a terrific increase of 20%. The latest three year period has also seen an excellent 98% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 9.7% per annum as estimated by the analysts watching the company. That's shaping up to be materially lower than the 14% per annum growth forecast for the broader market.

In light of this, it's alarming that NetEase's P/E sits above the majority of other companies. 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.

The Final Word

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.

We've established that NetEase 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.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for NetEase with six simple checks on some of these key factors.

If you're unsure about the strength of NetEase's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.