With a price-to-earnings (or "P/E") ratio of 17.6x Xiamen Faratronic Co., Ltd. (SHSE:600563) 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 53x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Xiamen Faratronic could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If you still 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?

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

Retrospectively, the last year delivered a frustrating 2.4% decrease to the company's bottom line. Even so, admirably EPS has lifted 61% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 16% per annum as estimated by the eight analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 24% per annum, which is noticeably more attractive.

In light of this, it's understandable that Xiamen Faratronic'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 Bottom Line On Xiamen Faratronic's P/E

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Xiamen Faratronic 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. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Xiamen Faratronic with six simple checks.

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

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