With a price-to-earnings (or "P/E") ratio of 5.1x Dongguang Chemical Limited (HKG:1702) may be sending bullish signals at the moment, given that almost half of all companies in Hong Kong have P/E ratios greater than 10x and even P/E's higher than 19x are not unusual. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.

Recent times have been quite advantageous for Dongguang Chemical as its earnings have been rising very briskly. 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.

See our latest analysis for Dongguang Chemical

Although there are no analyst estimates available for Dongguang Chemical, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Dongguang Chemical's Growth Trending?

In order to justify its P/E ratio, Dongguang Chemical would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered an exceptional 79% gain to the company's bottom line. Although, its longer-term performance hasn't been as strong with three-year EPS growth being relatively non-existent overall. So it appears to us that the company has had a mixed result in terms of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 23% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

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.

The Bottom Line On Dongguang Chemical'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.

As we suspected, our examination of Dongguang Chemical revealed its three-year earnings trends are contributing to its low P/E, given they look worse than current market expectations. At this stage investors feel the potential for an improvement in earnings isn't great enough to justify a higher P/E ratio. If recent medium-term earnings trends continue, it's hard to see the share price rising strongly in the near future under these circumstances.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Dongguang Chemical with six simple checks.

It's important to make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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