Those holding Chongqing Machinery & Electric Co., Ltd. (HKG:2722) shares would be relieved that the share price has rebounded 33% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Looking further back, the 19% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Even after such a large jump in price, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") above 10x, you may still consider Chongqing Machinery & Electric as an attractive investment with its 6.5x P/E ratio. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Chongqing Machinery & Electric certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for Chongqing Machinery & Electric

Does Growth Match The Low P/E?

Chongqing Machinery & Electric's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the market.

Retrospectively, the last year delivered an exceptional 62% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 33% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

In contrast to the company, the rest of the market is expected to grow by 18% over the next year, which really puts the company's recent medium-term earnings decline into perspective.

In light of this, it's understandable that Chongqing Machinery & Electric's P/E would sit below the majority of other companies. 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 Chongqing Machinery & Electric's P/E?

Despite Chongqing Machinery & Electric's shares building up a head of steam, its P/E still lags most other companies. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Chongqing Machinery & Electric revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

You should always think about risks. Case in point, we've spotted 2 warning signs for Chongqing Machinery & Electric you should be aware of, and 1 of them is a bit concerning.

If you're unsure about the strength of Chongqing Machinery & Electric's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.