Changhong Meiling Co., Ltd.'s (SZSE:000521) price-to-earnings (or "P/E") ratio of 12x 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 50x 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.

Recent times have been pleasing for Changhong Meiling as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, 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?

In order to justify its P/E ratio, Changhong Meiling would need to produce anemic growth that's substantially trailing the market.

Taking a look back first, we see that the company grew earnings per share by an impressive 47% last year. The strong recent performance means it was also able to grow EPS by 400% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Shifting to the future, estimates from the two analysts covering the company suggest earnings should grow by 12% per year over the next three years. That's shaping up to be materially lower than the 19% each year growth forecast for the broader market.

In light of this, it's understandable that Changhong Meiling's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Bottom Line On Changhong Meiling's P/E

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Changhong Meiling 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. It's hard to see the share price rising strongly in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Changhong Meiling, and understanding should be part of your investment process.

Of course, you might also be able to find a better stock than Changhong Meiling. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.