Shanghai Mechanical & Electrical Industry Co.,Ltd.'s (SHSE:600835) Price Is Right But Growth Is Lacking After Shares Rocket 36%

The Shanghai Mechanical & Electrical Industry Co.,Ltd. (SHSE:600835) share price has done very well over the last month, posting an excellent gain of 36%. The last 30 days bring the annual gain to a very sharp 98%.

In spite of the firm bounce in price, Shanghai Mechanical & Electrical IndustryLtd may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 26.9x, since almost half of all companies in China have P/E ratios greater than 39x and even P/E's higher than 75x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

With earnings that are retreating more than the market's of late, Shanghai Mechanical & Electrical IndustryLtd has been very sluggish. It seems that many are expecting the dismal earnings performance to persist, which has repressed the P/E. You'd much rather the company wasn't bleeding earnings if you still believe in the business. If not, then existing shareholders will probably struggle to get excited about the future direction of the share price.

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How Is Shanghai Mechanical & Electrical IndustryLtd's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as low as Shanghai Mechanical & Electrical IndustryLtd'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 12%. The last three years don't look nice either as the company has shrunk EPS by 20% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Turning to the outlook, the next year should generate growth of 23% as estimated by the dual analysts watching the company. That's shaping up to be materially lower than the 37% growth forecast for the broader market.

In light of this, it's understandable that Shanghai Mechanical & Electrical IndustryLtd's P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth 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 Shanghai Mechanical & Electrical IndustryLtd's P/E close to the market median. 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 Shanghai Mechanical & Electrical IndustryLtd's 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shanghai Mechanical & Electrical IndustryLtd, and understanding them should be part of your investment process.

If these risks are making you reconsider your opinion on Shanghai Mechanical & Electrical IndustryLtd, 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.