Shanghai M&G Stationery Inc.'s (SHSE:603899) price-to-earnings (or "P/E") ratio of 21.2x 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 32x and even P/E's above 57x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

Recent times have been pleasing for Shanghai M&G Stationery as its earnings have risen in spite of the market's earnings going into reverse. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for Shanghai M&G Stationery

How Is Shanghai M&G Stationery's Growth Trending?

There's an inherent assumption that a company should underperform the market for P/E ratios like Shanghai M&G Stationery's to be considered reasonable.

Retrospectively, the last year delivered a decent 7.8% gain to the company's bottom line. The solid recent performance means it was also able to grow EPS by 23% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing earnings over that time.

Turning to the outlook, the next year should generate growth of 25% as estimated by the analysts watching the company. That's shaping up to be materially lower than the 42% growth forecast for the broader market.

With this information, we can see why Shanghai M&G Stationery 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 Final Word

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 Shanghai M&G Stationery's analyst forecasts revealed that its inferior earnings outlook 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. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Before you take the next step, you should know about the 1 warning sign for Shanghai M&G Stationery that we have uncovered.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.