With a price-to-earnings (or "P/E") ratio of 19.7x Henan Lingrui Pharmaceutical Co., Ltd. (SHSE:600285) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 28x and even P/E's higher than 52x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

Henan Lingrui Pharmaceutical certainly has been doing a good job lately as it's been growing earnings more than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. 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.

What Are Growth Metrics Telling Us About The Low P/E?

In order to justify its P/E ratio, Henan Lingrui Pharmaceutical would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered an exceptional 27% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 79% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Turning to the outlook, the next three years should generate growth of 14% each year as estimated by the three analysts watching the company. That's shaping up to be materially lower than the 24% each year growth forecast for the broader market.

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

The Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Henan Lingrui Pharmaceutical maintains its low P/E on the weakness of its forecast growth being lower than the wider market, 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. It's hard to see the share price rising strongly in the near future under these circumstances.

Before you settle on your opinion, we've discovered 1 warning sign for Henan Lingrui Pharmaceutical that you should be aware of.

If these risks are making you reconsider your opinion on Henan Lingrui Pharmaceutical, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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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