Hangcha Group Co., Ltd's (SHSE:603298) price-to-earnings (or "P/E") ratio of 12.3x 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.

Recent times have been pleasing for Hangcha Group 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 not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

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

The only time you'd be truly comfortable seeing a P/E as depressed as Hangcha Group's is when the company's growth is on track to lag the market decidedly.

Retrospectively, the last year delivered an exceptional 39% gain to the company's bottom line. Pleasingly, EPS has also lifted 93% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 11% per year as estimated by the twelve analysts watching the company. That's shaping up to be materially lower than the 19% per annum growth forecast for the broader market.

In light of this, it's understandable that Hangcha Group'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 Key Takeaway

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 Hangcha Group maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Hangcha Group you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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