Henan Liliang Diamond Co., Ltd.'s (SZSE:301071) price-to-earnings (or "P/E") ratio of 20x 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 55x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Henan Liliang Diamond could be doing better as its earnings have been going backwards lately while most other companies have been seeing positive earnings growth. The P/E is probably low because investors think this poor earnings performance isn't going to get any better. If this is the case, then existing shareholders will probably struggle to get excited 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 low as Henan Liliang Diamond's is when the company's growth is on track to lag 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 15%. Still, the latest three year period has seen an excellent 143% 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.

Turning to the outlook, the next three years should generate growth of 22% per annum as estimated by the three analysts watching the company. Meanwhile, the rest of the market is forecast to expand by 21% per year, which is not materially different.

In light of this, it's peculiar that Henan Liliang Diamond's P/E sits below the majority of other companies. It may be that most investors are not convinced the company can achieve future growth expectations.

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.

We've established that Henan Liliang Diamond currently trades on a lower than expected P/E since its forecast growth is in line with the wider market. There could be some unobserved threats to earnings preventing the P/E ratio from matching the outlook. It appears some are indeed anticipating earnings instability, because these conditions should normally provide more support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Henan Liliang Diamond (at least 1 which can't be ignored), and understanding these should be part of your investment process.

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.