Shanghai GenTech Co., Ltd. (SHSE:688596) shareholders would be excited to see that the share price has had a great month, posting a 34% gain and recovering from prior weakness. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 7.6% over the last year.

In spite of the firm bounce in price, Shanghai GenTech's price-to-earnings (or "P/E") ratio of 27.3x might still make it look like a buy right now compared to the market in China, where around half of the companies have P/E ratios above 34x and even P/E's above 65x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Shanghai GenTech has been struggling lately as its earnings have declined faster than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. 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 Shanghai GenTech's to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 2.8%. Still, the latest three year period has seen an excellent 106% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 38% per year during the coming three years according to the three analysts following the company. With the market only predicted to deliver 19% each year, the company is positioned for a stronger earnings result.

With this information, we find it odd that Shanghai GenTech is trading at a P/E lower than the market. It looks like most investors are not convinced at all that the company can achieve future growth expectations.

The Final Word

Shanghai GenTech's stock might have been given a solid boost, but its P/E certainly hasn't reached any great heights. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Shanghai GenTech's analyst forecasts revealed that its superior earnings outlook isn't contributing to its P/E anywhere near as much as we would have predicted. 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.

Having said that, be aware Shanghai GenTech is showing 4 warning signs in our investment analysis, and 1 of those doesn't sit too well with us.

Of course, you might also be able to find a better stock than Shanghai GenTech. 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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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.