China Hongguang Holdings Limited (HKG:8646) shareholders have had their patience rewarded with a 40% share price jump in the last month. Looking back a bit further, it's encouraging to see the stock is up 28% in the last year.

In spite of the firm bounce in price, given about half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") above 9x, you may still consider China Hongguang Holdings as a highly attractive investment with its 3.4x P/E ratio. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

For instance, China Hongguang Holdings' receding earnings in recent times would have to be some food for thought. It might be that many expect the disappointing earnings performance to continue or accelerate, which has repressed the P/E. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

Is There Any Growth For China Hongguang Holdings?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 20%. Even so, admirably EPS has lifted 125% in aggregate from three years ago, notwithstanding the last 12 months. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

This is in contrast to the rest of the market, which is expected to grow by 19% over the next year, materially lower than the company's recent medium-term annualised growth rates.

With this information, we find it odd that China Hongguang Holdings is trading at a P/E lower than the market. It looks like most investors are not convinced the company can maintain its recent growth rates.

The Final Word

Shares in China Hongguang Holdings are going to need a lot more upward momentum to get the company's P/E out of its slump. 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.

Our examination of China Hongguang Holdings revealed its three-year earnings trends aren't contributing to its P/E anywhere near as much as we would have predicted, given they look better than current market expectations. When we see strong earnings 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 if recent medium-term earnings trends continue, but investors seem to think future earnings could see a lot of volatility.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for China Hongguang Holdings that you should be aware of.

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

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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.