Huafon Chemical Co.,Ltd's (SZSE:002064) price-to-earnings (or "P/E") ratio of 15.4x might make it look like a strong buy right now compared to the market in China, where around half of the companies have P/E ratios above 35x and even P/E's above 68x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

Recent times have been pleasing for Huafon ChemicalLtd as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. 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.

What Are Growth Metrics Telling Us About The Low P/E?

Huafon ChemicalLtd's P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 9.4% last year. Still, lamentably EPS has fallen 66% in aggregate from three years ago, which is 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 33% over the next year. That's shaping up to be materially lower than the 41% growth forecast for the broader market.

In light of this, it's understandable that Huafon ChemicalLtd's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Final Word

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 Huafon ChemicalLtd maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You always need to take note of risks, for example - Huafon ChemicalLtd has 1 warning sign we think you should be aware of.

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.