How low can you go? That’s the question many investors are asking about China Security & Surveillance Technology (NYSE: CSR). Shares keep on dropping, and the forward P/E ratio, which had been a paltry six, then drifted to five, is now below four. Any stock with a P/E ratio below four is worth a deeper look, and in this instance, the downward drift appears unwarranted. Even if the P/E ratio drifts back up to six or seven, then investors are looking at a +50% gain in the market.

CSR is one the leading suppliers of security gear to companies and governments in China. The company has posted impressive growth as sales have risen at least +35% in each of the last four years. But growing pains have also been the norm: CSR badly trailed profit forecasts in the middle quarters of 2009, straining credibility with investors. The weak results were due to sudden expected drops in gross margins, thanks to a change in the sales mix toward cost-sensitive corporate customers and away from government contracts. It didn’t help that CSR has announced several unexpected secondary stock offerings to raise cash either.

The combination of rising sales, weakening margins and a rising share count have led per share profits to flat line. During the past four years, per share profits have only risen from $0.85 in 2006 to $1.01 in 2009 — hardly the kind of growth you’d expect from a leading industry player in the world’s fastest-growing economy. Then again, nothing to sneeze at for a five dollar stock.

Yet the era of plunging margins looks set to end: CSR has begun to sign more government contracts, which typically carry gross margins 500 basis points higher than corporate contracts. The spurt in government business is attributable to a “safe-city” program that seeks to deploy banks of video cameras, traffic management systems and emergency response systems in China’s 200 largest cities. The company has recently scored several large new deals in this area, and (unfortunately) will be raising another $120 million from investors to assure Chinese government officials that the company has the financial strength to complete large projects. Government sales, which currently account for about 55% of revenue, should steadily rise as CSR inked four new government contracts in the first quarter alone for around $340 million.

The new government contracts have helped push CSR’s backlog for delivery within the next 12 months up to $200 million from $114 million a year ago. That should help CSR meet analysts’ sales forecasts in coming quarters, but the real test will be in the area of Accounts Receivable. In the most recent quarter, uncollected bills piled up, and the company now has an alarmingly high 224 Days Sales Outstanding (DSOs) worth of receivables due to it. Management insists that the spike is largely due to timing, as many systems were shipped during the Chinese New Year holiday. If they’re right, and Receivables DSO fall sharply, then investors will quickly renew their interest in the stock.

Besides the questions around the Accounts Receivable, shares have been under pressure while the company tries to complete the equity offering noted earlier. But with shares now so weak, management may seek other sources of funding that are less dilutive to the stock. Either way, the removal of this overhang serves as another key catalyst.

Of course, future per share profit forecasts will hinge on how many new shares are issued in the coming capital raise. Prior to any action, analysts expect CSR to boost profits around +20% next year to about $1.37, thanks to those recently-signed government deals. Shares trade for about four times that outlook.

Assuming that the company expands the share count by about 15%, then shares still trade for less than five times projected 2010 profits, far too low for a company still sporting impressive growth prospects.