Yinchuan Xinhua Commercial (Group) Co., Ltd. (SHSE:600785) shareholders won't be pleased to see that the share price has had a very rough month, dropping 28% and undoing the prior period's positive performance. Longer-term shareholders would now have taken a real hit with the stock declining 8.8% in the last year.

Since its price has dipped substantially, Yinchuan Xinhua Commercial (Group)'s price-to-earnings (or "P/E") ratio of 24.7x 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 32x and even P/E's above 60x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Recent earnings growth for Yinchuan Xinhua Commercial (Group) has been in line with the market. It might be that many expect the mediocre earnings performance to degrade, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could pick up some stock while it's out of favour.

What Are Growth Metrics Telling Us About The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Yinchuan Xinhua Commercial (Group)'s to be considered reasonable.

Taking a look back first, we see that there was hardly any earnings per share growth to speak of for the company over the past year. Although pleasingly EPS has lifted 250% in aggregate from three years ago, notwithstanding the last 12 months. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the one analyst covering the company suggest earnings should grow by 11% per year over the next three years. With the market predicted to deliver 26% growth each year, the company is positioned for a weaker earnings result.

With this information, we can see why Yinchuan Xinhua Commercial (Group) is trading at a P/E lower than the market. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Key Takeaway

The softening of Yinchuan Xinhua Commercial (Group)'s shares means its P/E is now sitting at a pretty low level. 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 Yinchuan Xinhua Commercial (Group)'s analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Yinchuan Xinhua Commercial (Group), and understanding should be part of your investment process.

You might be able to find a better investment than Yinchuan Xinhua Commercial (Group). If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.