It's not a stretch to say that Huarong Chemical Co., Ltd.'s (SZSE:301256) price-to-earnings (or "P/E") ratio of 33.6x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 34x. Although, it's not wise to simply ignore the P/E without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

As an illustration, earnings have deteriorated at Huarong Chemical over the last year, which is not ideal at all. One possibility is that the P/E is moderate because investors think the company might still do enough to be in line with the broader market in the near future. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

Is There Some Growth For Huarong Chemical?

The only time you'd be comfortable seeing a P/E like Huarong Chemical's is when the company's growth is tracking the market closely.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 40%. This means it has also seen a slide in earnings over the longer-term as EPS is down 32% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 36% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

In light of this, it's somewhat alarming that Huarong Chemical's P/E sits in line with the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent earnings trends is likely to weigh on the share price eventually.

The Bottom Line On Huarong Chemical's P/E

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.

Our examination of Huarong Chemical revealed its shrinking earnings over the medium-term aren't impacting its P/E as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the moderate P/E lower. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Huarong Chemical, and understanding them should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and 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.