With a price-to-earnings (or "P/E") ratio of 21.9x Tonghua Dongbao Pharmaceutical Co., Ltd. (SHSE:600867) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 35x and even P/E's higher than 64x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Recent times haven't been advantageous for Tonghua Dongbao Pharmaceutical as its earnings have been falling quicker than most other companies. The P/E is probably low because investors think this poor earnings performance isn't going to improve at all. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.

See our latest analysis for Tonghua Dongbao Pharmaceutical

Is There Any Growth For Tonghua Dongbao Pharmaceutical?

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

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 43%. Regardless, EPS has managed to lift by a handy 10% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been mostly respectable for the company.

Shifting to the future, estimates from the six analysts covering the company suggest earnings should grow by 31% over the next year. Meanwhile, the rest of the market is forecast to expand by 43%, which is noticeably more attractive.

With this information, we can see why Tonghua Dongbao Pharmaceutical is trading at a P/E lower than the market. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Key Takeaway

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 Tonghua Dongbao Pharmaceutical's analyst forecasts revealed that its inferior earnings outlook 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. It's hard to see the share price rising strongly in the near future under these circumstances.

Before you take the next step, you should know about the 2 warning signs for Tonghua Dongbao Pharmaceutical that we have uncovered.

You might be able to find a better investment than Tonghua Dongbao Pharmaceutical. 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.