The Vatti Corporation Limited (SZSE:002035) share price has done very well over the last month, posting an excellent gain of 28%. Looking back a bit further, it's encouraging to see the stock is up 34% in the last year.

In spite of the firm bounce in price, Vatti may still be sending very bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 13.7x, since almost half of all companies in China have P/E ratios greater than 30x and even P/E's higher than 58x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Vatti has been doing quite well of late. 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.

Does Growth Match The Low P/E?

In order to justify its P/E ratio, Vatti 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 201% last year. As a result, it also grew EPS by 5.2% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 17% each 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.

With this information, we can see why Vatti is trading at a P/E lower than the market. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Key Takeaway

Shares in Vatti are going to need a lot more upward momentum to get the company's P/E out of its slump. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Vatti's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

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

If you're unsure about the strength of Vatti'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.