Shengtak New Material Co., Ltd (SZSE:300881) shareholders would be excited to see that the share price has had a great month, posting a 48% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 17% over that time.

Even after such a large jump in price, given about half the companies in China have price-to-earnings ratios (or "P/E's") above 32x, you may still consider Shengtak New Material as an attractive investment with its 27.6x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's exceedingly strong of late, Shengtak New Material has been doing very well. 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.

How Is Shengtak New Material's Growth Trending?

In order to justify its P/E ratio, Shengtak New Material would need to produce sluggish growth that's trailing the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 47% last year. EPS has also lifted 24% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Therefore, it's fair to say the earnings growth recently has been respectable 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.

With this information, we can see why Shengtak New Material is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.

The Key Takeaway

Despite Shengtak New Material's shares building up a head of steam, its P/E still lags most other companies. We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Shengtak New Material 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.

You should always think about risks. Case in point, we've spotted 3 warning signs for Shengtak New Material you should be aware of, and 1 of them makes us a bit uncomfortable.

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.