Shanghai Waigaoqiao Free Trade Zone Group Co., Ltd.'s (SHSE:600648) price-to-earnings (or "P/E") ratio of 12.2x 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 33x and even P/E's above 61x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.
Shanghai Waigaoqiao Free Trade Zone Group certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
Does Growth Match The Low P/E?
The only time you'd be truly comfortable seeing a P/E as depressed as Shanghai Waigaoqiao Free Trade Zone Group's is when the company's growth is on track to lag the market decidedly.
If we review the last year of earnings growth, the company posted a terrific increase of 90%. However, this wasn't enough as the latest three year period has seen a very unpleasant 2.1% drop in EPS in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
In contrast to the company, the rest of the market is expected to grow by 38% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
With this information, we are not surprised that Shanghai Waigaoqiao Free Trade Zone Group is trading at a P/E lower than the market. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. Even just maintaining these prices could be difficult to achieve as recent earnings trends are already weighing down the shares.
The Bottom Line On Shanghai Waigaoqiao Free Trade Zone Group's P/E
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.
We've established that Shanghai Waigaoqiao Free Trade Zone Group maintains its low P/E on the weakness of its sliding earnings over the medium-term, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. 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.
You need to take note of risks, for example - Shanghai Waigaoqiao Free Trade Zone Group has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.
It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).
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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.