There wouldn't be many who think Changzhou Shichuang Energy Co.,Ltd.'s (SHSE:688429) price-to-earnings (or "P/E") ratio of 33.2x is worth a mention when the median P/E in China is similar at about 31x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

For example, consider that Changzhou Shichuang EnergyLtd's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is moderate because investors think the company might still do enough to be in line with the broader market in the near future. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

How Is Changzhou Shichuang EnergyLtd's Growth Trending?

In order to justify its P/E ratio, Changzhou Shichuang EnergyLtd would need to produce growth that's similar to the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 42%. Regardless, EPS has managed to lift by a handy 11% in aggregate from three years ago, thanks to the earlier period of growth. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.

This is in contrast to the rest of the market, which is expected to grow by 36% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's curious that Changzhou Shichuang EnergyLtd's P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as a continuation of recent earnings trends is likely to weigh down the shares eventually.

The Final Word

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.

We've established that Changzhou Shichuang EnergyLtd currently trades on a higher than expected P/E since its recent three-year growth is lower than the wider market forecast. Right now we are uncomfortable with the P/E as this earnings performance isn't likely to support a more positive sentiment for long. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

Plus, you should also learn about this 1 warning sign we've spotted with Changzhou Shichuang EnergyLtd.

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.