To the annoyance of some shareholders, Ningbo Gaofa Automotive Control System Co., Ltd. (SHSE:603788) shares are down a considerable 27% in the last month, which continues a horrid run for the company. Longer-term shareholders would now have taken a real hit with the stock declining 7.9% in the last year.

In spite of the heavy fall in price, given about half the companies in China have price-to-earnings ratios (or "P/E's") above 28x, you may still consider Ningbo Gaofa Automotive Control System as an attractive investment with its 19x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

The earnings growth achieved at Ningbo Gaofa Automotive Control System 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.

Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Ningbo Gaofa Automotive Control System's to be considered reasonable.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 8.5% last year. However, this wasn't enough as the latest three year period has seen an unpleasant 27% overall drop in EPS. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's an unpleasant look.

In light of this, it's understandable that Ningbo Gaofa Automotive Control System's P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Bottom Line On Ningbo Gaofa Automotive Control System's P/E

Ningbo Gaofa Automotive Control System's P/E has taken a tumble along with its share price. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Ningbo Gaofa Automotive Control System revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

You need to take note of risks, for example - Ningbo Gaofa Automotive Control System has 3 warning signs (and 2 which are a bit concerning) we think you should know about.

You might be able to find a better investment than Ningbo Gaofa Automotive Control System. 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.