With a price-to-earnings (or "P/E") ratio of 20.5x Shanghai Huafon Aluminium Corporation (SHSE:601702) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 36x and even P/E's higher than 65x 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 limited.

The earnings growth achieved at Shanghai Huafon Aluminium over the last year would be more than acceptable for most companies. One possibility is that the P/E is low because investors think this respectable earnings growth might actually underperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

View our latest analysis for Shanghai Huafon Aluminium

Is There Any Growth For Shanghai Huafon Aluminium?

There's an inherent assumption that a company should underperform the market for P/E ratios like Shanghai Huafon Aluminium's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 23% last year. The strong recent performance means it was also able to grow EPS by 172% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

It's interesting to note that the rest of the market is similarly expected to grow by 43% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.

In light of this, it's peculiar that Shanghai Huafon Aluminium's P/E sits below the majority of other companies. It may be that most investors are not convinced the company can maintain recent growth rates.

The Key Takeaway

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 Shanghai Huafon Aluminium currently trades on a lower than expected P/E since its recent three-year growth is in line with the wider market forecast. When we see average earnings with market-like growth, we assume potential risks are what might be placing pressure on the P/E ratio. At least the risk of a price drop looks to be subdued if recent medium-term earnings trends continue, but investors seem to think future earnings could see some volatility.

You should always think about risks. Case in point, we've spotted 1 warning sign for Shanghai Huafon Aluminium you should be aware of.

Of course, you might also be able to find a better stock than Shanghai Huafon Aluminium. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.