With a price-to-earnings (or "P/E") ratio of 18.4x Guoguang Electric Company Limited (SZSE:002045) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 29x and even P/E's higher than 54x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Recent times have been advantageous for Guoguang Electric as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. 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.

Is There Any Growth For Guoguang Electric?

In order to justify its P/E ratio, Guoguang Electric would need to produce sluggish growth that's trailing the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 58% last year. The latest three year period has also seen a 26% overall rise in EPS, aided extensively by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 4.4% each year as estimated by the four analysts watching the company. With the market predicted to deliver 25% growth per year, the company is positioned for a weaker earnings result.

In light of this, it's understandable that Guoguang Electric's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Final Word

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 Guoguang Electric maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Guoguang Electric you should know about.

Of course, you might also be able to find a better stock than Guoguang Electric. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com