ZTE Corporation (SZSE:000063) shareholders would be excited to see that the share price has had a great month, posting a 42% gain and recovering from prior weakness. Notwithstanding the latest gain, the annual share price return of 4.1% isn't as impressive.

Although its price has surged higher, ZTE's price-to-earnings (or "P/E") ratio of 17.1x 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 64x 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.

ZTE certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. One possibility is that the P/E is low because investors think the company's earnings are going to fall away like everyone else's soon. 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.

How Is ZTE's Growth Trending?

In order to justify its P/E ratio, ZTE would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered a decent 6.1% gain to the company's bottom line. This was backed up an excellent period prior to see EPS up by 42% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 8.0% per year as estimated by the twelve analysts watching the company. With the market predicted to deliver 19% growth each year, the company is positioned for a weaker earnings result.

In light of this, it's understandable that ZTE's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Key Takeaway

Despite ZTE's shares building up a head of steam, its P/E still lags most other companies. 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 ZTE'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 ZTE, and understanding should be part of your investment process.

If you're unsure about the strength of ZTE's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.