The Guangdong Dongfang Precision Science & Technology Co., Ltd. (SZSE:002611) share price has softened a substantial 28% over the previous 30 days, handing back much of the gains the stock has made lately. Looking back over the past twelve months the stock has been a solid performer regardless, with a gain of 22%.

Following the heavy fall in price, Guangdong Dongfang Precision Science & Technology's price-to-earnings (or "P/E") ratio of 17.1x 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 30x and even P/E's above 54x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

For instance, Guangdong Dongfang Precision Science & Technology's receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

What Are Growth Metrics Telling Us About The Low P/E?

In order to justify its P/E ratio, Guangdong Dongfang Precision Science & Technology would need to produce sluggish growth that's trailing the market.

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 2.4%. Still, the latest three year period has seen an excellent 41% overall rise in EPS, in spite of its unsatisfying short-term performance. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 36% shows it's noticeably less attractive on an annualised basis.

With this information, we can see why Guangdong Dongfang Precision Science & Technology is trading at a P/E lower than the market. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.

The Key Takeaway

Guangdong Dongfang Precision Science & Technology's recently weak share price has pulled its P/E below most other companies. 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 Guangdong Dongfang Precision Science & Technology revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Guangdong Dongfang Precision Science & Technology, and understanding them should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.