Nanjing Develop Advanced Manufacturing Co., Ltd.'s (SHSE:688377) price-to-earnings (or "P/E") ratio of 17x 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 27x and even P/E's above 51x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

As an illustration, earnings have deteriorated at Nanjing Develop Advanced Manufacturing over the last year, which is not ideal at all. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming 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.

Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like Nanjing Develop Advanced Manufacturing's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 20% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 179% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

This is in contrast to the rest of the market, which is expected to grow by 36% over the next year, materially lower than the company's recent medium-term annualised growth rates.

In light of this, it's peculiar that Nanjing Develop Advanced Manufacturing's P/E sits below the majority of other companies. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.

The Key Takeaway

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 Nanjing Develop Advanced Manufacturing currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. At least price risks look to be very low if recent medium-term earnings trends continue, but investors seem to think future earnings could see a lot of volatility.

Before you settle on your opinion, we've discovered 1 warning sign for Nanjing Develop Advanced Manufacturing that you should be aware of.

You might be able to find a better investment than Nanjing Develop Advanced Manufacturing. 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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