With a price-to-earnings (or "P/E") ratio of 26.3x Xiangyang Changyuandonggu Industry Co., Ltd. (SHSE:603950) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 34x and even P/E's higher than 61x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Recent times have been quite advantageous for Xiangyang Changyuandonggu Industry as its earnings have been rising very briskly. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for Xiangyang Changyuandonggu Industry

Does Growth Match The Low P/E?

The only time you'd be truly comfortable seeing a P/E as low as Xiangyang Changyuandonggu Industry's is when the company's growth is on track to lag the market.

If we review the last year of earnings growth, the company posted a terrific increase of 74%. However, this wasn't enough as the latest three year period has seen a very unpleasant 52% drop in EPS in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 43% 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 Xiangyang Changyuandonggu Industry 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. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Key Takeaway

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Xiangyang Changyuandonggu Industry 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 take the next step, you should know about the 2 warning signs for Xiangyang Changyuandonggu Industry that we have uncovered.

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.