REF Holdings Limited (HKG:1631) Stock Rockets 32% As Investors Are Less Pessimistic Than Expected

REF Holdings Limited (HKG:1631) shareholders would be excited to see that the share price has had a great month, posting a 32% gain and recovering from prior weakness. The last month tops off a massive increase of 128% in the last year.

Since its price has surged higher, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 11x, you may consider REF Holdings as a stock to avoid entirely with its 26.4x 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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As an illustration, earnings have deteriorated at REF Holdings 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Check out our latest analysis for REF Holdings

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on REF Holdings' earnings, revenue and cash flow.

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 REF Holdings' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 30%. The last three years don't look nice either as the company has shrunk EPS by 55% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 21% shows it's an unpleasant look.

With this information, we find it concerning that REF Holdings is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

REF Holdings' P/E is flying high just like its stock has during the last month. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that REF Holdings currently trades on a much higher than expected P/E since its recent earnings have been in decline over the medium-term. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these prices as being reasonable.

Having said that, be aware REF Holdings is showing 3 warning signs in our investment analysis, and 1 of those doesn't sit too well with us.

You might be able to find a better investment than REF Holdings. 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.