Despite an already strong run, Zhejiang Taitan Co.,Ltd. (SZSE:003036) shares have been powering on, with a gain of 28% in the last thirty days. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 14% over that time.

Even after such a large jump in price, Zhejiang TaitanLtd may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 26.5x, since almost half of all companies in China have P/E ratios greater than 36x and even P/E's higher than 71x are not unusual. 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 Zhejiang TaitanLtd'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. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

How Is Zhejiang TaitanLtd's Growth Trending?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 35%. Even so, admirably EPS has lifted 36% in aggregate from three years ago, notwithstanding the last 12 months. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 39% shows it's noticeably less attractive on an annualised basis.

In light of this, it's understandable that Zhejiang TaitanLtd's P/E sits below the majority of other companies. 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 Final Word

The latest share price surge wasn't enough to lift Zhejiang TaitanLtd's P/E close to the market median. 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 Zhejiang TaitanLtd revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Zhejiang TaitanLtd (1 is potentially serious!) that you should be aware of before investing here.

Of course, you might also be able to find a better stock than Zhejiang TaitanLtd. 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.