Shenzhen Gas Corporation Ltd.'s (SHSE:601139) price-to-earnings (or "P/E") ratio of 15.6x might make it look like a buy right now compared to the market in China, where around half of the companies have P/E ratios above 31x and even P/E's above 56x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.
With earnings growth that's superior to most other companies of late, Shenzhen Gas has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. 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.
Does Growth Match The Low P/E?
The only time you'd be truly comfortable seeing a P/E as low as Shenzhen Gas' is when the company's growth is on track to lag the market.
Taking a look back first, we see that the company grew earnings per share by an impressive 19% last year. As a result, it also grew EPS by 8.7% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.
Shifting to the future, estimates from the nine analysts covering the company suggest earnings should grow by 19% per year over the next three years. With the market predicted to deliver 20% growth each year, the company is positioned for a comparable earnings result.
With this information, we find it odd that Shenzhen Gas is trading at a P/E lower than the market. Apparently some shareholders are doubtful of the forecasts and have been accepting lower selling prices.
The Final Word
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.
We've established that Shenzhen Gas currently trades on a lower than expected P/E since its forecast growth is in line with the wider market. There could be some unobserved threats to earnings preventing the P/E ratio from matching the outlook. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see some volatility.
Before you settle on your opinion, we've discovered 2 warning signs for Shenzhen Gas (1 is significant!) 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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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.