Lacklustre Performance Is Driving Dongguang Chemical Limited's (HKG:1702) 27% Price Drop

Dongguang Chemical Limited (HKG:1702) shares have had a horrible month, losing 27% after a relatively good period beforehand. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 27% in that time.

In spite of the heavy fall in price, given about half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") above 11x, you may still consider Dongguang Chemical as a highly attractive investment with its 4x 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.

Dongguang Chemical certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. One possibility is that the P/E is low because investors think this strong earnings growth might actually underperform the broader market in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

View our latest analysis for Dongguang Chemical

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Dongguang Chemical's earnings, revenue and cash flow.

What Are Growth Metrics Telling Us About The Low P/E?

There's an inherent assumption that a company should far underperform the market for P/E ratios like Dongguang Chemical's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 79% gain to the company's bottom line. However, the latest three year period hasn't been as great in aggregate as it didn't manage to provide any growth at all. Therefore, it's fair to say that earnings growth has been inconsistent recently for the company.

Weighing that recent medium-term earnings trajectory against the broader market's one-year forecast for expansion of 21% shows it's noticeably less attractive on an annualised basis.

In light of this, it's understandable that Dongguang Chemical's P/E sits below the majority of other companies. Apparently many shareholders weren't comfortable holding on to something they believe will continue to trail the bourse.

What We Can Learn From Dongguang Chemical's P/E?

Shares in Dongguang Chemical have plummeted and its P/E is now low enough to touch the ground. 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 Dongguang Chemical maintains its low P/E on the weakness of its recent three-year growth being lower than the wider market forecast, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.

You should always think about risks. Case in point, we've spotted 1 warning sign for Dongguang Chemical you should be aware of.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.

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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.