Weichai Heavy Machinery Co., Ltd. (SZSE:000880) shareholders would be excited to see that the share price has had a great month, posting a 32% gain and recovering from prior weakness. 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, Weichai Heavy Machinery may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 20.7x, since almost half of all companies in China have P/E ratios greater than 28x and even P/E's higher than 53x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Weichai Heavy Machinery has been doing a good job lately as it's been growing earnings at a solid pace. One possibility is that the P/E is low because investors think this respectable 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 Weichai Heavy Machinery's Growth Trending?

There's an inherent assumption that a company should underperform the market for P/E ratios like Weichai Heavy Machinery's to be considered reasonable.

If we review the last year of earnings growth, the company posted a terrific increase of 23%. The latest three year period has also seen an excellent 53% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's noticeably less attractive on an annualised basis.

In light of this, it's understandable that Weichai Heavy Machinery's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.

The Key Takeaway

Despite Weichai Heavy Machinery's shares building up a head of steam, its P/E still lags most other companies. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Weichai Heavy Machinery maintains its low P/E on the weakness of its recent three-year growth being lower than the wider market forecast, as expected. 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.

Before you take the next step, you should know about the 1 warning sign for Weichai Heavy Machinery that we have uncovered.

You might be able to find a better investment than Weichai Heavy Machinery. 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.

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