Jinghua Pharmaceutical Group Co., Ltd.'s (SZSE:002349) price-to-earnings (or "P/E") ratio of 29.2x might 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 36x 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.

For example, consider that Jinghua Pharmaceutical Group's financial performance has been poor lately as its earnings have been in decline. 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?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 9.3%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 57% in total over the last three years. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

This is in contrast to the rest of the market, which is expected to grow by 40% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we can see why Jinghua Pharmaceutical Group is trading at a P/E lower than the market. It seems most investors are expecting to see the recent limited growth rates continue into the future and are only willing to pay a reduced amount for the stock.

The Bottom Line On Jinghua Pharmaceutical Group's P/E

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Jinghua Pharmaceutical Group revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. 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.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Jinghua Pharmaceutical Group that you should be aware of.

If you're unsure about the strength of Jinghua Pharmaceutical Group'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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