Why Investors Shouldn't Be Surprised By Skyworth Group Limited's (HKG:751) 31% Share Price Surge

The Skyworth Group Limited (HKG:751) share price has done very well over the last month, posting an excellent gain of 31%. Looking back a bit further, it's encouraging to see the stock is up 66% in the last year.

Following the firm bounce in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 12x, you may consider Skyworth Group as a stock to avoid entirely with its 24.3x P/E ratio. However, the P/E might be quite high for a reason and it requires further investigation to determine if it's justified.

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While the market has experienced earnings growth lately, Skyworth Group's earnings have gone into reverse gear, which is not great. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Skyworth Group

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 Skyworth Group's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 71% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 73% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next year should generate growth of 153% as estimated by the only analyst watching the company. Meanwhile, the rest of the market is forecast to only expand by 20%, which is noticeably less attractive.

In light of this, it's understandable that Skyworth Group's P/E sits above the majority of other companies. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

What We Can Learn From Skyworth Group's P/E?

The strong share price surge has got Skyworth Group's P/E rushing to great heights as well. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Skyworth Group maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 2 warning signs for Skyworth Group you should be aware of.

If you're unsure about the strength of Skyworth Group'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.