HUAYU Automotive Systems Company Limited's (SHSE:600741) price-to-earnings (or "P/E") ratio of 7.4x might make it look like a strong buy right now compared to the market in China, where around half of the companies have P/E ratios above 33x and even P/E's above 61x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.
There hasn't been much to differentiate HUAYU Automotive Systems' and the market's earnings growth lately. One possibility is that the P/E is low because investors think this modest earnings performance may begin to slide. If you like the company, you'd be hoping this isn't the case so that you could pick up some stock while it's out of favour.
Does Growth Match The Low P/E?
There's an inherent assumption that a company should far underperform the market for P/E ratios like HUAYU Automotive Systems' to be considered reasonable.
Retrospectively, the last year delivered virtually the same number to the company's bottom line as the year before. Regardless, EPS has managed to lift by a handy 7.5% in aggregate from three years ago, thanks to the earlier period of growth. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.
Looking ahead now, EPS is anticipated to climb by 0.3% per year during the coming three years according to the analysts following the company. That's shaping up to be materially lower than the 26% each year growth forecast for the broader market.
With this information, we can see why HUAYU Automotive Systems is trading at a P/E lower than the market. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.
The Key Takeaway
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
As we suspected, our examination of HUAYU Automotive Systems' analyst forecasts revealed that its inferior earnings outlook is contributing to its low P/E. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. It's hard to see the share price rising strongly in the near future under these circumstances.
Don't forget that there may be other risks. For instance, we've identified 2 warning signs for HUAYU Automotive Systems (1 is a bit unpleasant) you should be aware of.
You might be able to find a better investment than HUAYU Automotive Systems. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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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.