The Shanxi Huhua Group Co., Ltd. (SZSE:003002) share price has done very well over the last month, posting an excellent gain of 57%. Unfortunately, despite the strong performance over the last month, the full year gain of 4.5% isn't as attractive.

Even after such a large jump in price, Shanxi Huhua Group may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 16.3x, 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 reduced P/E.

Shanxi Huhua Group certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. 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?

There's an inherent assumption that a company should underperform the market for P/E ratios like Shanxi Huhua Group's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 67% last year. Pleasingly, EPS has also lifted 71% 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.

This is in contrast to the rest of the market, which is expected to grow by 36% over the next year, materially higher than the company's recent medium-term annualised growth rates.

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

What We Can Learn From Shanxi Huhua Group's P/E?

Despite Shanxi Huhua Group's shares building up a head of steam, its P/E still lags most other companies. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Shanxi Huhua Group revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Shanxi Huhua Group that you should be aware of.

Of course, you might also be able to find a better stock than Shanxi Huhua Group. 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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