With a price-to-earnings (or "P/E") ratio of 24.5x XJ Electric Co., Ltd. (SZSE:000400) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 35x and even P/E's higher than 63x 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.

XJ Electric 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. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for XJ Electric

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

There's an inherent assumption that a company should underperform the market for P/E ratios like XJ Electric's to be considered reasonable.

Retrospectively, the last year delivered a decent 11% gain to the company's bottom line. The solid recent performance means it was also able to grow EPS by 29% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Turning to the outlook, the next year should generate growth of 23% as estimated by the analysts watching the company. That's shaping up to be materially lower than the 44% growth forecast for the broader market.

With this information, we can see why XJ Electric is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Bottom Line On XJ Electric's P/E

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.

As we suspected, our examination of XJ Electric's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. 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.

Having said that, be aware XJ Electric is showing 1 warning sign in our investment analysis, you should know about.

You might be able to find a better investment than XJ Electric. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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.