Take Care Before Diving Into The Deep End On Huadong Medicine Co., Ltd (SZSE:000963)

With a price-to-earnings (or "P/E") ratio of 19.4x Huadong Medicine Co., Ltd (SZSE:000963) may be sending bullish signals at the moment, given that almost half of all companies in China have P/E ratios greater than 39x and even P/E's higher than 76x 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 its earnings growth in positive territory compared to the declining earnings of most other companies, Huadong Medicine has been doing quite well of late. One possibility is that the P/E is low because investors think the company's earnings are going to fall away like everyone else's soon. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

Check out our latest analysis for Huadong Medicine

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How Is Huadong Medicine's Growth Trending?

Huadong Medicine'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, we see that the company grew earnings per share by an impressive 19% last year. The strong recent performance means it was also able to grow EPS by 38% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the twelve analysts covering the company suggest earnings should grow by 17% each year over the next three years. That's shaping up to be similar to the 19% each year growth forecast for the broader market.

With this information, we find it odd that Huadong Medicine is trading at a P/E lower than the market. It may be that most investors are not convinced the company can achieve future growth expectations.

The Bottom Line On Huadong Medicine's P/E

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 Huadong Medicine 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. At least the risk of a price drop looks to be subdued, but investors seem to think future earnings could see some volatility.

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

Of course, you might also be able to find a better stock than Huadong Medicine. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.