Explosive Co., Ltd.'s (SZSE:002096) price-to-earnings (or "P/E") ratio of 21x 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 37x and even P/E's above 74x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

This technology could replace computers: discover the 20 stocks are working to make quantum computing a reality.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Explosive has been doing quite well of late. 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.

What Are Growth Metrics Telling Us About The Low P/E?

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

If we review the last year of earnings, the company posted a result that saw barely any deviation from a year ago. However, a few strong years before that means that it was still able to grow EPS by an impressive 342% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Turning to the outlook, the next three years should generate growth of 15% each year as estimated by the six analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 20% per annum, which is noticeably more attractive.

In light of this, it's understandable that Explosive's P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

What We Can Learn From Explosive's P/E?

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 Explosive's analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Explosive you should know about.

You might be able to find a better investment than Explosive. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.