YouYou Foods Co., Ltd. (SHSE:603697) shares have continued their recent momentum with a 25% gain in the last month alone. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 2.6% in the last twelve months.

Even after such a large jump in price, YouYou Foods' price-to-earnings (or "P/E") ratio of 26.3x 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 35x and even P/E's above 70x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

As an illustration, earnings have deteriorated at YouYou Foods over the last year, which is not ideal at all. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming 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.

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

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 18%. As a result, earnings from three years ago have also fallen 41% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Comparing that to the market, which is predicted to deliver 38% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.

With this information, we are not surprised that YouYou Foods is trading at a P/E lower than the market. 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

The latest share price surge wasn't enough to lift YouYou Foods' P/E close to the market median. 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 YouYou Foods revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless the recent medium-term 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 YouYou Foods that you should be aware of.

You might be able to find a better investment than YouYou Foods. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.