The Luyan Pharma Co.,Ltd. (SZSE:002788) share price has fared very poorly over the last month, falling by a substantial 29%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 26% in that time.

Since its price has dipped substantially, Luyan PharmaLtd's price-to-earnings (or "P/E") ratio of 7x 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 27x and even P/E's above 48x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

Earnings have risen firmly for Luyan PharmaLtd recently, which is pleasing to see. 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 far underperform the market for P/E ratios like Luyan PharmaLtd's to be considered reasonable.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 8.3% last year. EPS has also lifted 16% in aggregate from three years ago, partly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's noticeably less attractive on an annualised basis.

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

What We Can Learn From Luyan PharmaLtd's P/E?

Luyan PharmaLtd's P/E looks about as weak as its stock price lately. 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 Luyan PharmaLtd revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

Before you settle on your opinion, we've discovered 2 warning signs for Luyan PharmaLtd (1 is concerning!) that you should be aware of.

If you're unsure about the strength of Luyan PharmaLtd'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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