Guizhou Tyre Co.,Ltd.'s (SZSE:000589) price-to-earnings (or "P/E") ratio of 7.1x might make it look like a strong buy right now compared to the market in China, where around half of the companies have P/E ratios above 27x and even P/E's above 51x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

With earnings growth that's superior to most other companies of late, Guizhou TyreLtd has been doing relatively well. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. 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.

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

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

If we review the last year of earnings growth, the company posted a terrific increase of 100%. Still, incredibly EPS has fallen 54% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the lone analyst covering the company suggest earnings should grow by 5.2% per annum over the next three years. That's shaping up to be materially lower than the 23% per year growth forecast for the broader market.

In light of this, it's understandable that Guizhou TyreLtd's P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Bottom Line On Guizhou TyreLtd's P/E

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Guizhou TyreLtd's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Guizhou TyreLtd, and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Guizhou TyreLtd, 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.