Tianqi Lithium Corporation's (SZSE:002466) price-to-earnings (or "P/E") ratio of 5.6x 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 36x and even P/E's above 65x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.

With earnings that are retreating more than the market's of late, Tianqi Lithium has been very sluggish. It seems that many are expecting the dismal earnings performance to persist, which has repressed the P/E. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

See our latest analysis for Tianqi Lithium

How Is Tianqi Lithium's Growth Trending?

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

Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 15%. This has erased any of its gains during the last three years, with practically no change in EPS being achieved in total. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Looking ahead now, EPS is anticipated to slump, contracting by 20% per annum during the coming three years according to the analysts following the company. With the market predicted to deliver 23% growth each year, that's a disappointing outcome.

In light of this, it's understandable that Tianqi Lithium's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

What We Can Learn From Tianqi Lithium'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.

As we suspected, our examination of Tianqi Lithium's analyst forecasts revealed that its outlook for shrinking earnings is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

You should always think about risks. Case in point, we've spotted 3 warning signs for Tianqi Lithium you should be aware of, and 1 of them is potentially serious.

You might be able to find a better investment than Tianqi Lithium. 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.