Guangxi LiuYao Group Co., Ltd's (SHSE:603368) price-to-earnings (or "P/E") ratio of 8.3x 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 35x and even P/E's above 67x 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 have been pleasing for Guangxi LiuYao Group as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

What Are Growth Metrics Telling Us About The Low P/E?

There's an inherent assumption that a company should far underperform the market for P/E ratios like Guangxi LiuYao Group's to be considered reasonable.

Taking a look back first, we see that the company managed to grow earnings per share by a handy 11% last year. The latest three year period has also seen a 23% overall rise in EPS, aided somewhat by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 12% per year during the coming three years according to the dual analysts following the company. That's shaping up to be materially lower than the 18% per annum growth forecast for the broader market.

With this information, we can see why Guangxi LiuYao Group 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

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

As we suspected, our examination of Guangxi LiuYao Group'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 2 warning signs with Guangxi LiuYao Group, and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Guangxi LiuYao Group, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.