Huadong Medicine Co., Ltd's (SZSE:000963) price-to-earnings (or "P/E") ratio of 20.1x 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 31x and even P/E's above 57x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

With earnings growth that's superior to most other companies of late, Huadong Medicine has been doing relatively well. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Does Growth Match The Low P/E?

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

If we review the last year of earnings growth, the company posted a worthy increase of 13%. Still, lamentably EPS has fallen 9.5% in aggregate from three years ago, which is disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next three years should generate growth of 31% per annum as estimated by the analysts watching the company. That's shaping up to be materially higher than the 19% per annum growth forecast for the broader market.

In light of this, it's peculiar that Huadong Medicine'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

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

Our examination of Huadong Medicine'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. When we see a strong earnings outlook with faster-than-market growth, we assume potential risks are what might be placing significant pressure on the P/E ratio. At least price risks look to be very low, but investors seem to think future earnings could see a lot of volatility.

Having said that, be aware Huadong Medicine is showing 1 warning sign in our investment analysis, you should know about.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.