With a price-to-earnings (or "P/E") ratio of 24.8x Nantong Guosheng Intelligence Technology Group Co., Ltd. (SHSE:688558) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 37x and even P/E's higher than 73x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

For example, consider that Nantong Guosheng Intelligence Technology Group's financial performance has been poor lately as its earnings have been in decline. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

Does Growth Match The Low P/E?

The only time you'd be truly comfortable seeing a P/E as low as Nantong Guosheng Intelligence Technology Group's is when the company's growth is on track to lag the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 15%. The last three years don't look nice either as the company has shrunk EPS by 33% in aggregate. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's an unpleasant look.

In light of this, it's understandable that Nantong Guosheng Intelligence Technology Group's P/E would sit below the majority of other companies. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

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.

As we suspected, our examination of Nantong Guosheng Intelligence Technology Group revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Nantong Guosheng Intelligence Technology Group with six simple checks on some of these key factors.

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

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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.