When close to half the companies in China have price-to-earnings ratios (or "P/E's") above 28x, you may consider Northeast Pharmaceutical Group Co., Ltd. (SZSE:000597) as an attractive investment with its 18.3x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

For instance, Northeast Pharmaceutical Group's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

What Are Growth Metrics Telling Us About The Low P/E?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 2.6%. Still, the latest three year period has seen an excellent 309% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's noticeably more attractive on an annualised basis.

With this information, we find it odd that Northeast Pharmaceutical Group is trading at a P/E lower than the market. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.

What We Can Learn From Northeast Pharmaceutical Group's P/E?

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Northeast Pharmaceutical Group revealed its three-year earnings trends aren't contributing to its P/E anywhere near as much as we would have predicted, given they look better than current market expectations. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.

Before you settle on your opinion, we've discovered 2 warning signs for Northeast Pharmaceutical Group that you should be aware of.

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.

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