Shandong Xinchao Energy Corporation Limited's (SHSE:600777) price-to-earnings (or "P/E") ratio of 8.6x 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 35x 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 highly reduced P/E.

As an illustration, earnings have deteriorated at Shandong Xinchao Energy 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.

Check out our latest analysis for Shandong Xinchao Energy

Is There Any Growth For Shandong Xinchao Energy?

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

Retrospectively, the last year delivered a frustrating 5.9% decrease to the company's bottom line. However, a few very strong years before that means that it was still able to grow EPS by an impressive 1,279% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

This is in contrast to the rest of the market, which is expected to grow by 44% over the next year, materially lower than the company's recent medium-term annualised growth rates.

In light of this, it's peculiar that Shandong Xinchao Energy's P/E sits below the majority of other companies. It looks like most investors are not convinced the company can maintain its recent growth rates.

What We Can Learn From Shandong Xinchao Energy's P/E?

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.

We've established that Shandong Xinchao Energy currently trades on a much lower than expected P/E since its recent three-year growth is higher than the wider market forecast. When we see strong earnings with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. It appears many are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.

Many other vital risk factors can be found on the company's balance sheet. Our free balance sheet analysis for Shandong Xinchao Energy 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 Shandong Xinchao Energy. 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.