Zhejiang Dafeng Industry Co., Ltd (SHSE:603081) shareholders are no doubt pleased to see that the share price has bounced 29% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 27% over that time.

Although its price has surged higher, Zhejiang Dafeng Industry's price-to-earnings (or "P/E") ratio of 25.1x might still make it look like a buy right now compared to the market in China, where around half of the companies have P/E ratios above 30x and even P/E's above 55x 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 limited.

Zhejiang Dafeng Industry has been struggling lately as its earnings have declined faster than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.

How Is Zhejiang Dafeng Industry's Growth Trending?

There's an inherent assumption that a company should underperform the market for P/E ratios like Zhejiang Dafeng Industry's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 53% decrease to the company's bottom line. As a result, earnings from three years ago have also fallen 33% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 216% during the coming year according to the two analysts following the company. That's shaping up to be materially higher than the 41% growth forecast for the broader market.

With this information, we find it odd that Zhejiang Dafeng Industry is trading at a P/E lower than the market. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

What We Can Learn From Zhejiang Dafeng Industry's P/E?

The latest share price surge wasn't enough to lift Zhejiang Dafeng Industry's P/E close to the market median. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

We've established that Zhejiang Dafeng Industry currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. At least price risks look to be very low, but investors seem to think future earnings could see a lot of volatility.

You should always think about risks. Case in point, we've spotted 4 warning signs for Zhejiang Dafeng Industry you should be aware of, and 1 of them shouldn't be ignored.

Of course, you might also be able to find a better stock than Zhejiang Dafeng Industry. 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.