With a price-to-earnings (or "P/E") ratio of 26.1x Novogene Co., Ltd. (SHSE:688315) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 35x and even P/E's higher than 68x 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.

The recently shrinking earnings for Novogene have been in line with the market. One possibility is that the P/E is low because investors think the company's earnings may begin to slide even faster. If you still like the company, you'd want its earnings trajectory to turn around before making any decisions. At the very least, you'd be hoping that earnings don't fall off a cliff if your plan is to pick up some stock while it's out of favour.

How Is Novogene's Growth Trending?

In order to justify its P/E ratio, Novogene 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 2.1%. As a result, earnings from three years ago have also fallen 17% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

Shifting to the future, estimates from the five analysts covering the company suggest earnings should grow by 23% over the next year. Meanwhile, the rest of the market is forecast to expand by 38%, which is noticeably more attractive.

In light of this, it's understandable that Novogene's P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

What We Can Learn From Novogene's P/E?

Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of Novogene's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Novogene with six simple checks.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.