New Huadu Technology Co., Ltd. (SZSE:002264) shares have retraced a considerable 28% in the last month, reversing a fair amount of their solid recent performance. Longer-term shareholders would now have taken a real hit with the stock declining 2.9% in the last year.

Even after such a large drop in price, New Huadu Technology's price-to-earnings (or "P/E") ratio of 17.6x might still make it look like a buy right now compared to the market in China, where around half of the companies have P/E ratios above 31x and even P/E's above 57x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Recent times have been quite advantageous for New Huadu Technology as its earnings have been rising very briskly. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. 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?

The only time you'd be truly comfortable seeing a P/E as low as New Huadu Technology's is when the company's growth is on track to lag the market.

Retrospectively, the last year delivered an exceptional 43% gain to the company's bottom line. The latest three year period has also seen an excellent 34% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 37% shows it's noticeably less attractive on an annualised basis.

With this information, we can see why New Huadu Technology is trading at a P/E lower than the market. 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.

The Key Takeaway

New Huadu Technology's recently weak share price has pulled its P/E below most other companies. 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 New Huadu Technology maintains its low P/E on the weakness of its recent three-year growth being lower than the wider market forecast, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for New Huadu Technology that you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.

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