When close to half the companies in China have price-to-earnings ratios (or "P/E's") above 29x, you may consider Shanghai Pret Composites Co., Ltd. (SZSE:002324) as an attractive investment with its 20.7x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Shanghai Pret Composites certainly has been doing a good job lately as it's been growing earnings more than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. 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 Shanghai Pret Composites?

In order to justify its P/E ratio, Shanghai Pret Composites would need to produce sluggish growth that's trailing the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 41% last year. Still, incredibly EPS has fallen 2.7% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the four analysts covering the company suggest earnings should grow by 30% per annum over the next three years. With the market only predicted to deliver 24% each year, the company is positioned for a stronger earnings result.

In light of this, it's peculiar that Shanghai Pret Composites' P/E sits below the majority of other companies. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

What We Can Learn From Shanghai Pret Composites' P/E?

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Shanghai Pret Composites currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. At least price risks look to be very low, but investors seem to think future earnings could see a lot of volatility.

Plus, you should also learn about these 2 warning signs we've spotted with Shanghai Pret Composites.

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