With a price-to-earnings (or "P/E") ratio of 15.5x Shandong Hualu-Hengsheng Chemical Co., Ltd. (SHSE:600426) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 31x and even P/E's higher than 58x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Shandong Hualu-Hengsheng Chemical hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If this is the case, then existing shareholders will probably struggle to get excited about the future direction of the share price.

How Is Shandong Hualu-Hengsheng Chemical's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as low as Shandong Hualu-Hengsheng Chemical's is when the company's growth is on track to lag the market.

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 43%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 98% 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.

Looking ahead now, EPS is anticipated to climb by 24% per annum during the coming three years according to the twelve analysts following the company. Meanwhile, the rest of the market is forecast to only expand by 20% each year, which is noticeably less attractive.

In light of this, it's peculiar that Shandong Hualu-Hengsheng Chemical's P/E sits below the majority of other companies. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

The Key Takeaway

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Shandong Hualu-Hengsheng Chemical's analyst forecasts revealed that its superior earnings outlook isn't contributing to its P/E anywhere near as much as we would have predicted. There could be some major unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

You need to take note of risks, for example - Shandong Hualu-Hengsheng Chemical has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

Of course, you might also be able to find a better stock than Shandong Hualu-Hengsheng Chemical. 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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