It's not a stretch to say that China Foods Limited's (HKG:506) price-to-earnings (or "P/E") ratio of 7.9x right now seems quite "middle-of-the-road" compared to the market in Hong Kong, where the median P/E ratio is around 10x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Recent times have been advantageous for China Foods as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. 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 not quite in favour.

Does Growth Match The P/E?

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

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. However, a few strong years before that means that it was still able to grow EPS by an impressive 39% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 7.0% per year during the coming three years according to the four analysts following the company. That's shaping up to be materially lower than the 12% per year growth forecast for the broader market.

In light of this, it's curious that China Foods' P/E sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Bottom Line On China Foods' P/E

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that China Foods currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. Right now we are uncomfortable with the P/E as the predicted future earnings aren't likely to support a more positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 1 warning sign for China Foods that we have uncovered.

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.