Cachet Pharmaceutical Co., Ltd. (SZSE:002462) shareholders that were waiting for something to happen have been dealt a blow with a 30% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 30% share price drop.

Since its price has dipped substantially, Cachet Pharmaceutical's price-to-earnings (or "P/E") ratio of 10.5x might 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 27x and even P/E's above 48x 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 so limited.

As an illustration, earnings have deteriorated at Cachet Pharmaceutical 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.

Does Growth Match The Low P/E?

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 15%. This means it has also seen a slide in earnings over the longer-term as EPS is down 21% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Weighing that medium-term earnings trajectory against the broader market's one-year forecast for expansion of 41% shows it's an unpleasant look.

With this information, we are not surprised that Cachet Pharmaceutical is trading at a P/E lower than the market. However, we think shrinking earnings are unlikely to lead to a stable P/E over the longer term, which could set up shareholders for future disappointment. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

What We Can Learn From Cachet Pharmaceutical's P/E?

Having almost fallen off a cliff, Cachet Pharmaceutical's share price has pulled its P/E way down as well. 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 Cachet Pharmaceutical revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. If recent medium-term earnings trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Cachet Pharmaceutical (1 is a bit concerning) you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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