Huadong Medicine Co., Ltd's (SZSE:000963) price-to-earnings (or "P/E") ratio of 16.7x might 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 29x and even P/E's above 54x 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.

With earnings growth that's superior to most other companies of late, Huadong Medicine has been doing relatively well. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. 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 out of favour.

Is There Any Growth For Huadong Medicine?

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

If we review the last year of earnings growth, the company posted a terrific increase of 15%. The latest three year period has also seen a 21% overall rise in EPS, aided extensively by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 19% per annum as estimated by the analysts watching the company. With the market predicted to deliver 25% growth each year, the company is positioned for a weaker earnings result.

With this information, we can see why Huadong Medicine 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 Bottom Line On Huadong Medicine's 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.

As we suspected, our examination of Huadong Medicine's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You always need to take note of risks, for example - Huadong Medicine has 1 warning sign we think you should be aware of.

If you're unsure about the strength of Huadong Medicine's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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.

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