Henan Liliang Diamond Co., Ltd. (SZSE:301071) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 10% over that time.

Even after such a large jump in price, given about half the companies in China have price-to-earnings ratios (or "P/E's") above 30x, you may still consider Henan Liliang Diamond as an attractive investment with its 22.4x 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.

Henan Liliang Diamond has been struggling lately as its earnings have declined faster than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to 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, Henan Liliang Diamond would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered a frustrating 16% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 40% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 26% per annum as estimated by the three analysts watching the company. With the market only predicted to deliver 19% per year, the company is positioned for a stronger earnings result.

In light of this, it's peculiar that Henan Liliang Diamond's P/E sits below the majority of other companies. It looks like most investors are not convinced at all that the company can achieve future growth expectations.

The Key Takeaway

Despite Henan Liliang Diamond's shares building up a head of steam, its P/E still lags most other companies. 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.

We've established that Henan Liliang Diamond currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. There could be some major unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. At least price risks look to be very low, but investors seem to think future earnings could see a lot of volatility.

Having said that, be aware Henan Liliang Diamond is showing 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant.

Of course, you might also be able to find a better stock than Henan Liliang Diamond. 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.