Shanghai Lianming Machinery Co., Ltd. (SHSE:603006) shareholders are no doubt pleased to see that the share price has bounced 34% in the last month, although it is still struggling to make up recently lost ground. Notwithstanding the latest gain, the annual share price return of 6.5% isn't as impressive.

Although its price has surged higher, Shanghai Lianming Machinery may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 17.1x, since almost half of all companies in China have P/E ratios greater than 32x and even P/E's higher than 58x 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.

The earnings growth achieved at Shanghai Lianming Machinery over the last year would be more than acceptable for most companies. It might be that many expect the respectable earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be optimistic about the future direction of the share price.

How Is Shanghai Lianming Machinery's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as low as Shanghai Lianming Machinery's is when the company's growth is on track to lag the market.

If we review the last year of earnings growth, the company posted a terrific increase of 20%. The latest three year period has also seen an excellent 47% overall rise in EPS, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing earnings over that time.

This is in contrast to the rest of the market, which is expected to grow by 41% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's understandable that Shanghai Lianming Machinery's P/E sits below the majority of other companies. It seems most investors are expecting to see the recent limited growth rates continue into the future and are only willing to pay a reduced amount for the stock.

The Key Takeaway

The latest share price surge wasn't enough to lift Shanghai Lianming Machinery's P/E close to the market median. 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.

We've established that Shanghai Lianming Machinery maintains its low P/E on the weakness of its recent three-year growth being lower than the wider market forecast, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

Before you settle on your opinion, we've discovered 1 warning sign for Shanghai Lianming Machinery that you should be aware of.

Of course, you might also be able to find a better stock than Shanghai Lianming Machinery. 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.