With a median price-to-earnings (or "P/E") ratio of close to 29x in China, you could be forgiven for feeling indifferent about Huaneng Lancang River Hydropower Inc.'s (SHSE:600025) P/E ratio of 26.5x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Recent times have been advantageous for Huaneng Lancang River Hydropower as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to wane, which has kept the P/E from rising. 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 not quite in favour.

Does Growth Match The P/E?

In order to justify its P/E ratio, Huaneng Lancang River Hydropower would need to produce growth that's similar to the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 16% last year. Pleasingly, EPS has also lifted 45% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 10% per annum during the coming three years according to the nine analysts following the company. With the market predicted to deliver 24% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's curious that Huaneng Lancang River Hydropower's P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for future disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

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.

We've established that Huaneng Lancang River Hydropower currently trades on a higher than expected P/E since its forecast growth is lower than the wider market. When we see a weak earnings outlook with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Huaneng Lancang River Hydropower (of which 1 is a bit unpleasant!) you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.

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