Shanxi Lanhua Sci-Tech Venture Co.,Ltd's (SHSE:600123) price-to-earnings (or "P/E") ratio of 12.7x 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 69x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

With earnings that are retreating more than the market's of late, Shanxi Lanhua Sci-Tech VentureLtd has been very sluggish. It seems that many are expecting the dismal earnings performance to persist, which has repressed the P/E. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

How Is Shanxi Lanhua Sci-Tech VentureLtd's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as depressed as Shanxi Lanhua Sci-Tech VentureLtd'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 56%. As a result, earnings from three years ago have also fallen 35% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next year should generate growth of 29% as estimated by the dual analysts watching the company. With the market predicted to deliver 39% growth , the company is positioned for a weaker earnings result.

In light of this, it's understandable that Shanxi Lanhua Sci-Tech VentureLtd'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

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.

We've established that Shanxi Lanhua Sci-Tech VentureLtd 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shanxi Lanhua Sci-Tech VentureLtd (at least 1 which is concerning), and understanding these should be part of your investment process.

Of course, you might also be able to find a better stock than Shanxi Lanhua Sci-Tech VentureLtd. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.