Hengsheng Energy Co., Ltd (SHSE:605580) shareholders that were waiting for something to happen have been dealt a blow with a 31% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 12% share price drop.

Although its price has dipped substantially, given about half the companies in China have price-to-earnings ratios (or "P/E's") above 27x, you may still consider Hengsheng Energy as an attractive investment with its 16x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

The earnings growth achieved at Hengsheng Energy over the last year would be more than acceptable for most companies. It might be that many expect the respectable earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be optimistic about the future direction of the share price.

Does Growth Match The Low P/E?

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

Taking a look back first, we see that the company managed to grow earnings per share by a handy 11% last year. Still, EPS has barely risen at all in aggregate from three years ago, which is not ideal. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's noticeably less attractive on an annualised basis.

In light of this, it's understandable that Hengsheng Energy's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.

The Final Word

The softening of Hengsheng Energy's shares means its P/E is now sitting at a pretty low level. 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.

As we suspected, our examination of Hengsheng Energy revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.

It is also worth noting that we have found 2 warning signs for Hengsheng Energy (1 makes us a bit uncomfortable!) that you need to take into consideration.

Of course, you might also be able to find a better stock than Hengsheng Energy. 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.