Hengtong Optic-Electric Co., Ltd.'s (SHSE:600487) price-to-earnings (or "P/E") ratio of 16.8x 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 55x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Hengtong Optic-Electric 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.

Does Growth Match The Low P/E?

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

Retrospectively, the last year delivered an exceptional 34% gain to the company's bottom line. The latest three year period has also seen an excellent 76% 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.

Looking ahead now, EPS is anticipated to climb by 18% 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 understandable that Hengtong Optic-Electric's P/E sits below the majority of other companies. 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 Hengtong Optic-Electric's P/E

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.

We've established that Hengtong Optic-Electric maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 1 warning sign for Hengtong Optic-Electric you should be aware of.

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

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