Allied Machinery Co., Ltd. (SHSE:605060) Held Back By Insufficient Growth Even After Shares Climb 40%

The Allied Machinery Co., Ltd. (SHSE:605060) share price has done very well over the last month, posting an excellent gain of 40%. The last 30 days bring the annual gain to a very sharp 34%.

In spite of the firm bounce in price, given about half the companies in China have price-to-earnings ratios (or "P/E's") above 35x, you may still consider Allied Machinery as an attractive investment with its 26.1x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

Allied Machinery has been struggling lately as its earnings have declined faster than most other companies. 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. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.

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Is There Any Growth For Allied Machinery?

Allied Machinery's P/E ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than 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 28%. The last three years don't look nice either as the company has shrunk EPS by 2.9% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Turning to the outlook, the next year should generate growth of 31% as estimated by the only analyst watching the company. That's shaping up to be materially lower than the 38% growth forecast for the broader market.

In light of this, it's understandable that Allied Machinery'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.

What We Can Learn From Allied Machinery's P/E?

The latest share price surge wasn't enough to lift Allied Machinery'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.

We've established that Allied Machinery maintains its low P/E on the weakness of its forecast growth being lower than the wider market, 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. It's hard to see the share price rising strongly in the near future under these circumstances.

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

If you're unsure about the strength of Allied Machinery's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.