Shanghai Aj Group Co.,Ltd's (SHSE:600643) price-to-earnings (or "P/E") ratio of 28.2x 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 64x are quite common. 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, Shanghai Aj GroupLtd'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. 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.

View our latest analysis for Shanghai Aj GroupLtd

Does Growth Match The Low P/E?

In order to justify its P/E ratio, Shanghai Aj GroupLtd would need to produce sluggish growth that's trailing the market.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 56%. As a result, earnings from three years ago have also fallen 78% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 44% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we are not surprised that Shanghai Aj GroupLtd is trading at a P/E lower than the market. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. Even just maintaining these prices could be difficult to achieve as recent earnings trends are already weighing down the shares.

The Final Word

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Shanghai Aj GroupLtd revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 10 warning signs with Shanghai Aj GroupLtd (at least 4 which shouldn't be ignored), and understanding these should be part of your investment process.

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.