Cheng De Lolo Company Limited's (SZSE:000848) price-to-earnings (or "P/E") ratio of 13.5x might make it look like a strong buy right now compared to the market in China, where around half of the companies have P/E ratios above 32x and even P/E's above 61x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

Recent times haven't been advantageous for Cheng De Lolo as its earnings have been falling quicker than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. 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?

In order to justify its P/E ratio, Cheng De Lolo would need to produce anemic growth that's substantially trailing the market.

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 3.2%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 24% overall rise in EPS. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Shifting to the future, estimates from the three analysts covering the company suggest earnings should grow by 10% per annum over the next three years. That's shaping up to be materially lower than the 19% per year growth forecast for the broader market.

With this information, we can see why Cheng De Lolo 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

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Cheng De Lolo maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. 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.

Before you settle on your opinion, we've discovered 2 warning signs for Cheng De Lolo (1 is concerning!) that you should be aware of.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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.