With a price-to-earnings (or "P/E") ratio of 5.4x First Tractor Company Limited (HKG:38) may be sending bullish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios greater than 9x and even P/E's higher than 18x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

First Tractor certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform 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.

Check out our latest analysis for First Tractor

What Are Growth Metrics Telling Us About The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like First Tractor's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 72% gain to the company's bottom line. Pleasingly, EPS has also lifted 81% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

It's interesting to note that the rest of the market is similarly expected to grow by 22% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.

With this information, we find it odd that First Tractor is trading at a P/E lower than the market. It may be that most investors are not convinced the company can maintain recent growth rates.

What We Can Learn From First Tractor'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.

We've established that First Tractor currently trades on a lower than expected P/E since its recent three-year growth is in line with the wider market forecast. When we see average earnings with market-like growth, we assume potential risks are what might be placing pressure on the P/E ratio. At least the risk of a price drop looks to be subdued if recent medium-term earnings trends continue, but investors seem to think future earnings could see some volatility.

Having said that, be aware First Tractor is showing 1 warning sign in our investment analysis, you should know about.

You might be able to find a better investment than First Tractor. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.