With a price-to-earnings (or "P/E") ratio of 25.4x China Petroleum Engineering Corporation (SHSE:600339) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 33x and even P/E's higher than 61x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.
Recent earnings growth for China Petroleum Engineering has been in line with the market. It might be that many expect the mediocre earnings performance to degrade, which has repressed the P/E. If not, then existing shareholders have reason to be optimistic about the future direction of the share price.
Does Growth Match The Low P/E?
There's an inherent assumption that a company should underperform the market for P/E ratios like China Petroleum Engineering's to be considered reasonable.
If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. This isn't what shareholders were looking for as it means they've been left with a 44% decline in EPS over the last three years in total. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 11% each year over the next three years. That's shaping up to be materially lower than the 26% each year growth forecast for the broader market.
In light of this, it's understandable that China Petroleum Engineering's P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.
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.
We've established that China Petroleum Engineering maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.
And what about other risks? Every company has them, and we've spotted 1 warning sign for China Petroleum Engineering you should know about.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.