Zhejiang Communications Technology Co., Ltd.'s (SZSE:002061) price-to-earnings (or "P/E") ratio of 7.2x might make it look like a strong buy right now compared to the market in China, where around half of the companies have P/E ratios above 36x and even P/E's above 65x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

With earnings that are retreating more than the market's of late, Zhejiang Communications Technology has been very sluggish. It seems that many are expecting the dismal earnings performance to persist, which has repressed the P/E. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.

View our latest analysis for Zhejiang Communications Technology

What Are Growth Metrics Telling Us About The Low P/E?

In order to justify its P/E ratio, Zhejiang Communications Technology would need to produce anemic growth that's substantially trailing the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 7.0%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 78% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Shifting to the future, estimates from the dual analysts covering the company suggest earnings should grow by 31% over the next year. Meanwhile, the rest of the market is forecast to expand by 43%, which is noticeably more attractive.

In light of this, it's understandable that Zhejiang Communications Technology's P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Final Word

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.

As we suspected, our examination of Zhejiang Communications Technology's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Zhejiang Communications Technology you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.