Hunan Valin Steel Co., Ltd.'s (SZSE:000932) price-to-earnings (or "P/E") ratio of 6.5x 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 27x and even P/E's above 51x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

With earnings that are retreating more than the market's of late, Hunan Valin Steel has been very sluggish. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.

How Is Hunan Valin Steel's Growth Trending?

There's an inherent assumption that a company should far underperform the market for P/E ratios like Hunan Valin Steel's to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 25%. As a result, earnings from three years ago have also fallen 62% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Looking ahead now, EPS is anticipated to climb by 8.8% per year during the coming three years according to the five analysts following the company. That's shaping up to be materially lower than the 20% per annum growth forecast for the broader market.

In light of this, it's understandable that Hunan Valin Steel'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 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.

As we suspected, our examination of Hunan Valin Steel's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Having said that, be aware Hunan Valin Steel is showing 2 warning signs in our investment analysis, you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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