Zhejiang Medicine Co., Ltd.'s (SHSE:600216) price-to-earnings (or "P/E") ratio of 18x might make it look like a buy right now compared to the market in China, where around half of the companies have P/E ratios above 35x and even P/E's above 68x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Zhejiang Medicine has been doing quite well of late. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. 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, Zhejiang Medicine would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered an exceptional 181% gain to the company's bottom line. As a result, it also grew EPS by 15% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Turning to the outlook, the next year should generate growth of 47% as estimated by the three analysts watching the company. That's shaping up to be materially higher than the 41% growth forecast for the broader market.

In light of this, it's peculiar that Zhejiang Medicine'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.

What We Can Learn From Zhejiang Medicine'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 Zhejiang Medicine's analyst forecasts revealed that its superior earnings outlook isn't contributing to its P/E anywhere near as much as we would have predicted. There could be some major unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Zhejiang Medicine 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.