With a price-to-earnings (or "P/E") ratio of 18.8x Shanghai Flyco Electrical Appliance Co., Ltd. (SHSE:603868) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 28x and even P/E's higher than 52x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

Shanghai Flyco Electrical Appliance hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. It seems that many are expecting the dour earnings performance to persist, which has repressed the P/E. If you still 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.

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 Shanghai Flyco Electrical Appliance's to be considered reasonable.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 3.7%. Still, the latest three year period has seen an excellent 34% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Looking ahead now, EPS is anticipated to climb by 17% per year during the coming three years according to the seven analysts following the company. With the market predicted to deliver 24% growth each year, the company is positioned for a weaker earnings result.

With this information, we can see why Shanghai Flyco Electrical Appliance is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Final Word

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.

We've established that Shanghai Flyco Electrical Appliance maintains its low P/E on the weakness of its forecast growth being lower than the wider market, 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. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Having said that, be aware Shanghai Flyco Electrical Appliance is showing 1 warning sign in our investment analysis, you should know about.

If these risks are making you reconsider your opinion on Shanghai Flyco Electrical Appliance, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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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