Shenzhen Topband Co., Ltd.'s (SZSE:002139) price-to-earnings (or "P/E") ratio of 22.1x 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 33x and even P/E's above 64x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Shenzhen Topband certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. One possibility is that the P/E is low because investors think the company's earnings are going to fall away like everyone else's soon. 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.

Does Growth Match The Low P/E?

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

Retrospectively, the last year delivered an exceptional 38% gain to the company's bottom line. Still, incredibly EPS has fallen 12% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the eight analysts covering the company suggest earnings should grow by 26% over the next year. With the market predicted to deliver 38% growth , the company is positioned for a weaker earnings result.

With this information, we can see why Shenzhen Topband is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

The Final Word

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 Shenzhen Topband'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. It's hard to see the share price rising strongly in the near future under these circumstances.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Shenzhen Topband with six simple checks will allow you to discover any risks that could be an issue.

Of course, you might also be able to find a better stock than Shenzhen Topband. 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.