Yangling Metron New Material Inc.'s (SZSE:300861) price-to-earnings (or "P/E") ratio of 8.5x 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 33x and even P/E's above 61x 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.

Yangling Metron New Material could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. It seems that many are expecting the dour earnings performance to persist, which has repressed the P/E. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

Is There Any Growth For Yangling Metron New Material?

There's an inherent assumption that a company should far underperform the market for P/E ratios like Yangling Metron New Material's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 10% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 159% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 11% per annum during the coming three years according to the four analysts following the company. With the market predicted to deliver 26% growth per year, that's a disappointing outcome.

In light of this, it's understandable that Yangling Metron New Material's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Yangling Metron New Material maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You always need to take note of risks, for example - Yangling Metron New Material has 2 warning signs we think you should be aware of.

Of course, you might also be able to find a better stock than Yangling Metron New Material. 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.