China Hongguang Holdings Limited (HKG:8646) shareholders would be excited to see that the share price has had a great month, posting a 29% gain and recovering from prior weakness. Taking a wider view, although not as strong as the last month, the full year gain of 25% is also fairly reasonable.

In spite of the firm bounce 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 China Hongguang Holdings as a highly attractive investment with its 2.5x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

Recent times have been quite advantageous for China Hongguang Holdings as its earnings have been rising very briskly. 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 China Hongguang Holdings

How Is China Hongguang Holdings' Growth Trending?

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

If we review the last year of earnings growth, the company posted a terrific increase of 275%. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 23% overall. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.

In contrast to the company, the rest of the market is expected to grow by 17% 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 China Hongguang Holdings' 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. Even just maintaining these prices could be difficult to achieve as recent earnings trends are already weighing down the shares.

The Bottom Line On China Hongguang Holdings' P/E

Even after such a strong price move, China Hongguang Holdings' P/E still trails the rest of the market significantly. 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 China Hongguang Holdings 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 need to take note of risks, for example - China Hongguang Holdings has 2 warning signs (and 1 which can't be ignored) we think you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies that have grown earnings strongly and trade on P/E's below 20x.

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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.