Chongqing Zongshen Power Machinery Co.,Ltd (SZSE:001696) shares have had a really impressive month, gaining 29% after a shaky period beforehand. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.
Although its price has surged higher, given about half the companies in China have price-to-earnings ratios (or "P/E's") above 32x, you may still consider Chongqing Zongshen Power MachineryLtd as an attractive investment with its 21.7x 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.
For instance, Chongqing Zongshen Power MachineryLtd's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.
We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Chongqing Zongshen Power MachineryLtd's earnings, revenue and cash flow.
What Are Growth Metrics Telling Us About The Low P/E?
Chongqing Zongshen Power MachineryLtd's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 26%. This means it has also seen a slide in earnings over the longer-term as EPS is down 37% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.
In contrast to the company, the rest of the market is expected to grow by 40% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
In light of this, it's understandable that Chongqing Zongshen Power MachineryLtd's P/E would sit below the majority of other companies. 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 Final Word
Despite Chongqing Zongshen Power MachineryLtd's shares building up a head of steam, its P/E still lags most other companies. 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.
As we suspected, our examination of Chongqing Zongshen Power MachineryLtd revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.
There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Chongqing Zongshen Power MachineryLtd that you should be aware of.
If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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