Daphne International Holdings Limited (HKG:210) shares have had a really impressive month, gaining 33% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 73%.

Although its price has surged higher, given about half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") above 10x, you may still consider Daphne International Holdings as an attractive investment with its 7x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Daphne International Holdings certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform 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.

Does Growth Match The Low P/E?

In order to justify its P/E ratio, Daphne International Holdings 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 65% last year. Still, EPS has barely risen at all from three years ago in total, which is not ideal. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

This is in contrast to the rest of the market, which is expected to grow by 19% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's understandable that Daphne International Holdings' P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.

The Key Takeaway

Daphne International Holdings' stock might have been given a solid boost, but its P/E certainly hasn't reached any great heights. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Daphne International Holdings maintains its low P/E on the weakness of its recent three-year growth being lower than the wider market forecast, 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. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.

Plus, you should also learn about these 4 warning signs we've spotted with Daphne International Holdings.

Of course, you might also be able to find a better stock than Daphne International Holdings. 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.

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