With a price-to-earnings (or "P/E") ratio of 19.2x China Automotive Engineering Research Institute Co., Ltd. (SHSE:601965) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 37x and even P/E's higher than 71x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

China Automotive Engineering Research Institute certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. One possibility is that the P/E is low because investors think the company's earnings are going to fall away like everyone else's soon. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

How Is China Automotive Engineering Research Institute's Growth Trending?

There's an inherent assumption that a company should underperform the market for P/E ratios like China Automotive Engineering Research Institute's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 19% gain to the company's bottom line. EPS has also lifted 27% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 20% over the next year. With the market predicted to deliver 38% growth , the company is positioned for a weaker earnings result.

With this information, we can see why China Automotive Engineering Research Institute is trading at a P/E lower than the market. 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

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that China Automotive Engineering Research Institute maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You should always think about risks. Case in point, we've spotted 1 warning sign for China Automotive Engineering Research Institute 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).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.