There wouldn't be many who think Rainbow Digital Commercial Co., Ltd.'s (SZSE:002419) price-to-earnings (or "P/E") ratio of 34.7x is worth a mention when the median P/E in China is similar at about 34x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/E.

With earnings that are retreating more than the market's of late, Rainbow Digital Commercial has been very sluggish. One possibility is that the P/E is moderate because investors think the company's earnings trend will eventually fall in line with most others in the market. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders may be a little nervous about the viability of the share price.

How Is Rainbow Digital Commercial's Growth Trending?

In order to justify its P/E ratio, Rainbow Digital Commercial would need to produce growth that's similar to 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 5.0%. The last three years don't look nice either as the company has shrunk EPS by 53% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 17% per year as estimated by the four analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 18% per year, which is not materially different.

In light of this, it's understandable that Rainbow Digital Commercial's P/E sits in line with the majority of other companies. Apparently shareholders are comfortable to simply hold on while the company is keeping a low profile.

The Final Word

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 Rainbow Digital Commercial maintains its moderate P/E off the back of its forecast growth being in line with the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings won't throw up any surprises. Unless these conditions change, they will continue to support the share price at these levels.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Rainbow Digital Commercial that you should be aware of.

Of course, you might also be able to find a better stock than Rainbow Digital Commercial. 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.