Shenzhen Laibao Hi-Tech Co., Ltd.'s (SZSE:002106) price-to-earnings (or "P/E") ratio of 23.9x 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 36x and even P/E's above 65x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

For example, consider that Shenzhen Laibao Hi-Tech's financial performance has been poor lately as its earnings have been in decline. 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 Shenzhen Laibao Hi-Tech

Is There Any Growth For Shenzhen Laibao Hi-Tech?

In order to justify its P/E ratio, Shenzhen Laibao Hi-Tech 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 29%. The last three years don't look nice either as the company has shrunk EPS by 15% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 43% shows it's an unpleasant look.

In light of this, it's understandable that Shenzhen Laibao Hi-Tech's P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Bottom Line On Shenzhen Laibao Hi-Tech'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.

As we suspected, our examination of Shenzhen Laibao Hi-Tech 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.

Before you settle on your opinion, we've discovered 2 warning signs for Shenzhen Laibao Hi-Tech that you should be aware of.

Of course, you might also be able to find a better stock than Shenzhen Laibao Hi-Tech. 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.