China BlueChemical Ltd.'s (HKG:3983) Shares Lagging The Market But So Is The Business

China BlueChemical Ltd.'s (HKG:3983) price-to-earnings (or "P/E") ratio of 4x might make it look like a strong buy right now compared to the market in Hong Kong, where around half of the companies have P/E ratios above 9x and even P/E's above 18x are quite common. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.

China BlueChemical 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. It might be that many expect the strong earnings performance to degrade substantially, possibly more than the market, which has repressed the P/E. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

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

China BlueChemical's P/E ratio would be typical for a company that's expected to deliver very poor growth or even falling earnings, and importantly, perform much worse than the market.

Retrospectively, the last year delivered an exceptional 104% gain to the company's bottom line. Pleasingly, EPS has also lifted 421% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Shifting to the future, estimates from the lone analyst covering the company suggest earnings growth is heading into negative territory, declining 11% per annum over the next three years. Meanwhile, the broader market is forecast to expand by 15% per annum, which paints a poor picture.

In light of this, it's understandable that China BlueChemical's P/E would sit below the majority of other companies. However, shrinking earnings are unlikely to lead to a stable P/E over the longer term. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.

The Bottom Line On China BlueChemical's P/E

Using the price-to-earnings ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that China BlueChemical maintains its low P/E on the weakness of its forecast for sliding earnings, 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. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with China BlueChemical (at least 1 which makes us a bit uncomfortable), and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on China BlueChemical, 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.