There wouldn't be many who think Pansoft Company Limited's (SZSE:300996) price-to-earnings (or "P/E") ratio of 26.9x is worth a mention when the median P/E in China is similar at about 26x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

Recent times haven't been advantageous for Pansoft as its earnings have been falling quicker than most other companies. One possibility is that the P/E is moderate because investors think the company's earnings trend will eventually fall in line with most others in the market. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping it doesn't keep underperforming if your plan is to pick up some stock while it's not in favour.

Does Growth Match The P/E?

The only time you'd be comfortable seeing a P/E like Pansoft's is when the company's growth is tracking the market closely.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 7.0%. The last three years don't look nice either as the company has shrunk EPS by 17% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 28% each year over the next three years. That's shaping up to be materially higher than the 19% per annum growth forecast for the broader market.

In light of this, it's curious that Pansoft's P/E sits in line with the majority of other companies. It may be that most investors aren't convinced the company can achieve future growth expectations.

The Final Word

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Pansoft currently trades on a lower than expected P/E since its forecast growth is higher than the wider market. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing pressure on the P/E ratio. It appears some are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

Plus, you should also learn about this 1 warning sign we've spotted with Pansoft.

If you're unsure about the strength of Pansoft's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.