Zhejiang Rongsheng Environmental Protection Paper Co., Ltd.'s (SHSE:603165) price-to-earnings (or "P/E") ratio of 10.2x 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 67x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

The earnings growth achieved at Zhejiang Rongsheng Environmental Protection Paper over the last year would be more than acceptable for most companies. 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?

Zhejiang Rongsheng Environmental Protection Paper'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.

If we review the last year of earnings growth, the company posted a terrific increase of 16%. As a result, it also grew EPS by 22% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been respectable for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 38% shows it's noticeably less attractive on an annualised basis.

With this information, we can see why Zhejiang Rongsheng Environmental Protection Paper is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.

What We Can Learn From Zhejiang Rongsheng Environmental Protection Paper's P/E?

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 Zhejiang Rongsheng Environmental Protection Paper revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Zhejiang Rongsheng Environmental Protection Paper (at least 1 which makes us a bit uncomfortable), and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Zhejiang Rongsheng Environmental Protection Paper, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.