Chongqing Changan Automobile Company Limited's (SZSE:000625) price-to-earnings (or "P/E") ratio of 14.1x 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 31x and even P/E's above 57x 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 its earnings growth in positive territory compared to the declining earnings of most other companies, Chongqing Changan Automobile has been doing quite well of late. 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 not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
What Are Growth Metrics Telling Us About The Low P/E?
The only time you'd be truly comfortable seeing a P/E as depressed as Chongqing Changan Automobile's is when the company's growth is on track to lag the market decidedly.
If we review the last year of earnings growth, the company posted a terrific increase of 44%. The strong recent performance means it was also able to grow EPS by 169% 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 15% during the coming year according to the analysts following the company. With the market predicted to deliver 41% growth , that's a disappointing outcome.
In light of this, it's understandable that Chongqing Changan Automobile'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. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.
What We Can Learn From Chongqing Changan Automobile's P/E?
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.
As we suspected, our examination of Chongqing Changan Automobile'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. It's hard to see the share price rising strongly in the near future under these circumstances.
And what about other risks? Every company has them, and we've spotted 2 warning signs for Chongqing Changan Automobile (of which 1 is potentially serious!) you should know about.
Of course, you might also be able to find a better stock than Chongqing Changan Automobile. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.