Jiuzhitang Co., Ltd. (SZSE:000989) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 20% in that time.

Although its price has dipped substantially, it's still not a stretch to say that Jiuzhitang's price-to-earnings (or "P/E") ratio of 24.7x right now seems quite "middle-of-the-road" compared to the market in China, where the median P/E ratio is around 26x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

As an illustration, earnings have deteriorated at Jiuzhitang over the last year, which is not ideal at all. One possibility is that the P/E is moderate because investors think the company might still do enough to be in line with the broader market in the near future. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

Is There Some Growth For Jiuzhitang?

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

Retrospectively, the last year delivered a frustrating 34% decrease to the company's bottom line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 8.9% overall rise in EPS. So we can start by confirming that the company has generally done a good job of growing earnings over that time, even though it had some hiccups along the way.

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 curious that Jiuzhitang's P/E sits in line with the majority of other companies. Apparently many investors in the company are less bearish than recent times would indicate and aren't willing to let go of their stock right now. They may be setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Final Word

Following Jiuzhitang's share price tumble, its P/E is now hanging on to the median market P/E. Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Jiuzhitang currently trades on a higher than expected P/E since its recent three-year growth is lower than the wider market forecast. When we see weak earnings with slower than market growth, we suspect the share price is at risk of declining, sending the moderate P/E lower. Unless the recent medium-term conditions improve, it's challenging to accept these prices as being reasonable.

Before you take the next step, you should know about the 2 warning signs for Jiuzhitang (1 is a bit concerning!) that we have uncovered.

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