When close to half the companies in China have price-to-earnings ratios (or "P/E's") above 32x, you may consider Zhejiang Tengen Electrics Co.,Ltd. (SHSE:605066) as an attractive investment with its 21.5x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Zhejiang Tengen ElectricsLtd 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.

Is There Any Growth For Zhejiang Tengen ElectricsLtd?

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

Taking a look back first, we see that the company grew earnings per share by an impressive 44% last year. Still, incredibly EPS has fallen 58% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 37% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's understandable that Zhejiang Tengen ElectricsLtd's P/E would sit below the majority of other companies. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. Even just maintaining these prices could be difficult to achieve as recent earnings trends are already weighing down the shares.

The Key Takeaway

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 Zhejiang Tengen ElectricsLtd revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

You should always think about risks. Case in point, we've spotted 2 warning signs for Zhejiang Tengen ElectricsLtd you should be aware of, and 1 of them is significant.

Of course, you might also be able to find a better stock than Zhejiang Tengen ElectricsLtd. 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.