When close to half the companies in the United Kingdom have price-to-earnings ratios (or "P/E's") above 16x, you may consider China New Energy Limited (LON:CNEL) as a highly attractive investment with its 4.9x P/E ratio. However, the P/E might be quite low for a reason and it requires further investigation to determine if it's justified.
With earnings growth that's exceedingly strong of late, China New Energy has been doing very well. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If that doesn't eventuate, then existing shareholders have reason to be quite optimistic about the future direction of the share price.
Where Does China New Energy's P/E Sit Within Its Industry?
It's plausible that China New Energy's particularly low P/E ratio could be a result of tendencies within its own industry. The image below shows that the Construction industry as a whole also has a P/E ratio lower than the market. So this goes some way towards explaining the company's ratio right now. In the context of the Construction industry's current setting, most of its constituents' P/E's would be expected to be toned down. We'd highlight though, the spotlight should be on the anticipated direction of the company's earnings.
Although there are no analyst estimates available for China New Energy, take a look at this free data-rich visualisation to see how the company stacks up on 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 China New Energy's to be considered reasonable.
If we review the last year of earnings growth, the company posted a terrific increase of 31%. The latest three year period has also seen an excellent 1421% overall rise in EPS, aided by its short-term performance. Therefore, it's fair to say the earnings growth recently has been superb for the company.
Comparing that to the market, which is predicted to shrink 15% in the next 12 months, the company's positive momentum based on recent medium-term earnings results is a bright spot for the moment.
With this information, we find it very odd that China New Energy is trading at a P/E lower than the market. Apparently some shareholders believe the recent performance has exceeded its limits and have been accepting significantly lower selling prices.
What We Can Learn From China New Energy's P/E?
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that China New Energy currently trades on a much lower than expected P/E since its recent three-year earnings growth is beating forecasts for a struggling market. There could be some major unobserved threats to earnings preventing the P/E ratio from matching this positive performance. One major risk is whether its earnings trajectory can keep outperforming under these tough market conditions. At least the risk of a price drop looks to be subdued, but investors think future earnings could see a lot of volatility.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with China New Energy (at least 1 which doesn't sit too well with us), and understanding them should be part of your investment process.
Of course, you might also be able to find a better stock than China New Energy. So you may wish to see this free collection of other companies that sit on P/E's below 20x and have grown earnings strongly.
This article by Simply Wall St is general in nature. 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.
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