Chongqing Machinery & Electric Co., Ltd. (HKG:2722) shareholders have had their patience rewarded with a 26% share price jump in the last month. Taking a wider view, although not as strong as the last month, the full year gain of 21% is also fairly reasonable.

Although its price has surged higher, Chongqing Machinery & Electric's price-to-earnings (or "P/E") ratio of 5.8x might still make it look like a buy right now compared to the market in Hong Kong, where around half of the companies have P/E ratios above 10x and even P/E's above 20x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Chongqing Machinery & Electric has been doing a good job lately as it's been growing earnings at a solid pace. It might be that many expect the respectable earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be optimistic about the future direction of the share price.

How Is Chongqing Machinery & Electric's Growth Trending?

There's an inherent assumption that a company should underperform the market for P/E ratios like Chongqing Machinery & Electric's to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 25% last year. The strong recent performance means it was also able to grow EPS by 79% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been superb for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 22% shows it's about the same on an annualised basis.

With this information, we find it odd that Chongqing Machinery & Electric is trading at a P/E lower than the market. Apparently some shareholders are more bearish than recent times would indicate and have been accepting lower selling prices.

The Bottom Line On Chongqing Machinery & Electric's P/E

Despite Chongqing Machinery & Electric's shares building up a head of steam, its P/E still lags most other companies. 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 Chongqing Machinery & Electric currently trades on a lower than expected P/E since its recent three-year growth is in line with the wider market forecast. When we see average earnings with market-like growth, we assume potential risks are what might be placing pressure on the P/E ratio. At least the risk of a price drop looks to be subdued if recent medium-term earnings trends continue, but investors seem to think future earnings could see some volatility.

You always need to take note of risks, for example - Chongqing Machinery & Electric has 2 warning signs we think you should be aware of.

You might be able to find a better investment than Chongqing Machinery & Electric. 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.