New Huadu Technology Co., Ltd. (SZSE:002264) shares have had a really impressive month, gaining 26% after a shaky period beforehand. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 2.5% over the last year.

In spite of the firm bounce in price, New Huadu Technology may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 18x, since almost half of all companies in China have P/E ratios greater than 30x and even P/E's higher than 55x are not unusual. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

For example, consider that New Huadu Technology's financial performance has been poor lately as its earnings have been in decline. 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. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

How Is New Huadu Technology's Growth Trending?

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

Retrospectively, the last year delivered a frustrating 18% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 34% overall rise in EPS, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.

Comparing that to the market, which is predicted to deliver 34% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

In light of this, it's understandable that New Huadu Technology'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 Final Word

The latest share price surge wasn't enough to lift New Huadu Technology's P/E close to the market median. 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.

We've established that New Huadu Technology maintains its low P/E on the weakness of its recent three-year growth being lower than the wider market forecast, as expected. 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.

And what about other risks? Every company has them, and we've spotted 1 warning sign for New Huadu Technology you should know about.

If these risks are making you reconsider your opinion on New Huadu Technology, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.