The Kehua Holdings Co.,Ltd (SHSE:603161) share price has done very well over the last month, posting an excellent gain of 27%. Notwithstanding the latest gain, the annual share price return of 2.2% isn't as impressive.

In spite of the firm bounce in price, given about half the companies in China have price-to-earnings ratios (or "P/E's") above 37x, you may still consider Kehua HoldingsLtd as a highly attractive investment with its 17.6x 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.

As an illustration, earnings have deteriorated at Kehua HoldingsLtd over the last year, which is not ideal at all. 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. 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?

The only time you'd be truly comfortable seeing a P/E as depressed as Kehua HoldingsLtd's is when the company's growth is on track to lag the market decidedly.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 16%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 67% in total over the last three years. 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 40% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's understandable that Kehua HoldingsLtd's P/E sits below the majority of other companies. It seems most investors are expecting to see the recent limited growth rates continue into the future and are only willing to pay a reduced amount for the stock.

The Final Word

Shares in Kehua HoldingsLtd are going to need a lot more upward momentum to get the company's P/E out of its slump. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Kehua HoldingsLtd revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Kehua HoldingsLtd (at least 1 which shouldn't be ignored), and understanding them should be part of your investment process.

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.