With a median price-to-earnings (or "P/E") ratio of close to 32x in China, you could be forgiven for feeling indifferent about Huabao Flavours & Fragrances Co., Ltd.'s (SZSE:300741) P/E ratio of 33.7x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

For instance, Huabao Flavours & Fragrances' receding earnings in recent times would have to be some food for thought. It might be that many expect the company to put the disappointing earnings performance behind them over the coming period, which has kept the P/E from falling. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

How Is Huabao Flavours & Fragrances' Growth Trending?

The only time you'd be comfortable seeing a P/E like Huabao Flavours & Fragrances' is when the company's growth is tracking the market closely.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 43%. The last three years don't look nice either as the company has shrunk EPS by 70% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 38% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's somewhat alarming that Huabao Flavours & Fragrances' P/E sits in line with the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Final Word

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.

Our examination of Huabao Flavours & Fragrances revealed its shrinking earnings over the medium-term aren't impacting its P/E as much as we would have predicted, given the market is set to grow. Right now we are uncomfortable with the P/E as this earnings performance is unlikely to support a more positive sentiment for long. If recent medium-term earnings trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

You need to take note of risks, for example - Huabao Flavours & Fragrances has 3 warning signs (and 2 which shouldn't be ignored) we think you should know about.

Of course, you might also be able to find a better stock than Huabao Flavours & Fragrances. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.