Xiangyang Changyuandonggu Industry Co., Ltd. (SHSE:603950) shareholders are no doubt pleased to see that the share price has bounced 27% in the last month, although it is still struggling to make up recently lost ground. Looking further back, the 13% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

In spite of the firm bounce in price, given about half the companies in China have price-to-earnings ratios (or "P/E's") above 31x, you may still consider Xiangyang Changyuandonggu Industry as an attractive investment with its 25.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Xiangyang Changyuandonggu Industry 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.

How Is Xiangyang Changyuandonggu Industry's Growth Trending?

In order to justify its P/E ratio, Xiangyang Changyuandonggu Industry would need to produce sluggish growth that's trailing the market.

If we review the last year of earnings growth, the company posted a terrific increase of 74%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 52% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 41% 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. Even just maintaining these prices could be difficult to achieve as recent earnings trends are already weighing down the shares.

The Bottom Line On Xiangyang Changyuandonggu Industry's P/E

Despite Xiangyang Changyuandonggu Industry's shares building up a head of steam, its P/E still lags most other companies. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Xiangyang Changyuandonggu Industry, and understanding them should be part of your investment process.

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.