With a median price-to-earnings (or "P/E") ratio of close to 30x in China, you could be forgiven for feeling indifferent about Zhongnongfa Seed Industry Group Co., Ltd.'s (SHSE:600313) P/E ratio of 28.4x. While this might not raise any eyebrows, if the P/E ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.
Zhongnongfa Seed Industry Group certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably moderate because investors think this strong earnings growth might not be enough to outperform the broader market in the near future. If that doesn't eventuate, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.
Does Growth Match The P/E?
There's an inherent assumption that a company should be matching the market for P/E ratios like Zhongnongfa Seed Industry Group's to be considered reasonable.
Taking a look back first, we see that the company grew earnings per share by an impressive 127% last year. The latest three year period has also seen an excellent 980% overall rise in EPS, aided by its short-term performance. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.
This is in contrast to the rest of the market, which is expected to grow by 36% over the next year, materially lower than the company's recent medium-term annualised growth rates.
With this information, we find it interesting that Zhongnongfa Seed Industry Group is trading at a fairly similar P/E to the market. Apparently some shareholders believe the recent performance is at its limits and have been accepting lower selling prices.
The Final Word
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 Zhongnongfa Seed Industry Group currently trades on a lower than expected P/E since its recent three-year growth is higher than the wider market forecast. There could be some unobserved threats to earnings preventing the P/E ratio from matching this positive performance. It appears some are indeed anticipating earnings instability, because the persistence of these recent medium-term conditions would normally provide a boost to the share price.
Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Zhongnongfa Seed Industry Group that you should be aware of.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on 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.