With a price-to-earnings (or "P/E") ratio of 20.3x Hangzhou Turbine Power Group Co., Ltd. (SZSE:200771) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 35x and even P/E's higher than 63x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.
For example, consider that Hangzhou Turbine Power 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. 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.
See our latest analysis for Hangzhou Turbine Power Group
What Are Growth Metrics Telling Us About The Low P/E?
There's an inherent assumption that a company should underperform the market for P/E ratios like Hangzhou Turbine Power Group's to be considered reasonable.
Retrospectively, the last year delivered a frustrating 36% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 13% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 44% shows it's an unpleasant look.
In light of this, it's understandable that Hangzhou Turbine Power Group's P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. Even just maintaining these prices could be difficult to achieve as recent earnings trends are already weighing down the shares.
The Key Takeaway
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 Hangzhou Turbine Power Group revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. 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 moving strongly in either direction in the near future under these circumstances.
Plus, you should also learn about these 2 warning signs we've spotted with Hangzhou Turbine Power Group.
If you're unsure about the strength of Hangzhou Turbine Power Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.