When close to half the companies in China have price-to-earnings ratios (or "P/E's") above 28x, you may consider Hunan Aihua Group Co., Ltd (SHSE:603989) as an attractive investment with its 19.6x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Recent times haven't been advantageous for Hunan Aihua Group as its earnings have been falling quicker than most other companies. It seems that many are expecting the dismal earnings performance to persist, which has repressed the P/E. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to 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 Hunan Aihua Group's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 35% decrease to the company's bottom line. The last three years don't look nice either as the company has shrunk EPS by 41% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 125% during the coming year according to the sole analyst following the company. That's shaping up to be materially higher than the 36% growth forecast for the broader market.

In light of this, it's peculiar that Hunan Aihua Group's P/E sits below the majority of other companies. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

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 Hunan Aihua Group currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. There could be some major unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. At least price risks look to be very low, but investors seem to think future earnings could see a lot of volatility.

You should always think about risks. Case in point, we've spotted 2 warning signs for Hunan Aihua Group you should be aware of.

You might be able to find a better investment than Hunan Aihua Group. 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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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.