With a price-to-earnings (or "P/E") ratio of 23.4x Guoguang Electric Company Limited (SZSE:002045) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 36x and even P/E's higher than 65x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Recent times have been pleasing for Guoguang Electric as its earnings have risen in spite of the market's earnings going into reverse. 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.

View our latest analysis for Guoguang Electric

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

In order to justify its P/E ratio, Guoguang Electric would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered an exceptional 244% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 73% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to slump, contracting by 14% during the coming year according to the dual analysts following the company. That's not great when the rest of the market is expected to grow by 44%.

With this information, we are not surprised that Guoguang Electric is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

The Final Word

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Guoguang Electric's analyst forecasts revealed that its outlook for shrinking earnings 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.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Guoguang Electric that you should be aware of.

You might be able to find a better investment than Guoguang Electric. 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).

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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.