Despite an already strong run, Ningbo Shimao Energy Co.,Ltd (SHSE:605028) shares have been powering on, with a gain of 28% in the last thirty days. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

In spite of the firm bounce in price, Ningbo Shimao EnergyLtd's price-to-earnings (or "P/E") ratio of 17.6x might still 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 36x and even P/E's above 70x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

As an illustration, earnings have deteriorated at Ningbo Shimao EnergyLtd 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?

The only time you'd be truly comfortable seeing a P/E as depressed as Ningbo Shimao EnergyLtd's is when the company's growth is on track to lag the market decidedly.

Retrospectively, the last year delivered a frustrating 16% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 27% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 41% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

With this information, we are not surprised that Ningbo Shimao EnergyLtd is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. Even just maintaining these prices could be difficult to achieve as recent earnings trends are already weighing down the shares.

The Key Takeaway

Shares in Ningbo Shimao EnergyLtd are going to need a lot more upward momentum to get the company's P/E out of its slump. Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Ningbo Shimao EnergyLtd maintains its low P/E on the weakness of its sliding earnings over the medium-term, as expected. 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 take the next step, you should know about the 1 warning sign for Ningbo Shimao EnergyLtd that we have uncovered.

If you're unsure about the strength of Ningbo Shimao EnergyLtd's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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