Huafon Chemical Co.,Ltd's (SZSE:002064) Low P/E No Reason For Excitement

When close to half the companies in China have price-to-earnings ratios (or "P/E's") above 27x, you may consider Huafon Chemical Co.,Ltd (SZSE:002064) as a highly attractive investment with its 12.6x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.

Huafon ChemicalLtd certainly has been doing a good job lately as its earnings growth has been positive while most other companies have been seeing their earnings go backwards. 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.

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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 Huafon ChemicalLtd's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 49% gain to the company's bottom line. Despite this strong recent growth, it's still struggling to catch up as its three-year EPS frustratingly shrank by 54% overall. 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 three years should generate growth of 15% per year as estimated by the three analysts watching the company. With the market predicted to deliver 19% growth per annum, the company is positioned for a weaker earnings result.

In light of this, it's understandable that Huafon ChemicalLtd's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on while the company is potentially eyeing a less prosperous future.

What We Can Learn From Huafon ChemicalLtd's P/E?

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 Huafon ChemicalLtd 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Huafon ChemicalLtd, and understanding should be part of your investment process.

Of course, you might also be able to find a better stock than Huafon ChemicalLtd. 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.