Yabao Pharmaceutical Group Co., Ltd's (SHSE:600351) price-to-earnings (or "P/E") ratio of 21.7x 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 34x and even P/E's above 65x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Yabao Pharmaceutical Group has been doing a good job lately as it's been growing earnings at a solid pace. One possibility is that the P/E is low because investors think this respectable earnings growth might actually underperform the broader market in the near future. If that doesn't eventuate, then existing shareholders have reason to be optimistic about the future direction of the share price.

Does Growth Match The Low P/E?

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

If we review the last year of earnings growth, the company posted a terrific increase of 27%. Pleasingly, EPS has also lifted 55% 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.

This is in contrast to the rest of the market, which is expected to grow by 36% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's understandable that Yabao Pharmaceutical Group's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.

The Final Word

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.

We've established that Yabao Pharmaceutical Group maintains its low P/E on the weakness of its recent three-year growth being lower than the wider market forecast, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Yabao Pharmaceutical Group that you should be aware of.

If these risks are making you reconsider your opinion on Yabao Pharmaceutical Group, explore our interactive list of high quality stocks to get an idea of what else is out there.

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