Jiangsu Rutong Petro-Machinery Co., Ltd (SHSE:603036) shareholders won't be pleased to see that the share price has had a very rough month, dropping 26% and undoing the prior period's positive performance. The recent drop has obliterated the annual return, with the share price now down 6.4% over that longer period.

Although its price has dipped substantially, Jiangsu Rutong Petro-Machinery's price-to-earnings (or "P/E") ratio of 23.7x might still make it look like a buy right now compared to the market in China, where around half of the companies have P/E ratios above 28x and even P/E's above 51x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

Jiangsu Rutong Petro-Machinery certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Jiangsu Rutong Petro-Machinery's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 49% gain to the company's bottom line. The latest three year period has also seen an excellent 39% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 42% shows it's noticeably less attractive on an annualised basis.

In light of this, it's understandable that Jiangsu Rutong Petro-Machinery's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.

The Final Word

Jiangsu Rutong Petro-Machinery's recently weak share price has pulled its P/E below most other companies. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Jiangsu Rutong Petro-Machinery revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Jiangsu Rutong Petro-Machinery, and understanding them should be part of your investment process.

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).

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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.