With a price-to-earnings (or "P/E") ratio of 3.3x China 21st Century Education Group Limited (HKG:1598) may be sending very 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 20x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/E.
China 21st Century Education Group has been doing a good job lately as it's been growing earnings at a solid pace. It might be that many expect the respectable earnings performance to degrade substantially, which has repressed the P/E. 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.
Check out our latest analysis for China 21st Century Education Group
Does Growth Match The Low P/E?
There's an inherent assumption that a company should far underperform the market for P/E ratios like China 21st Century Education Group's to be considered reasonable.
Taking a look back first, we see that the company managed to grow earnings per share by a handy 9.9% last year. However, this wasn't enough as the latest three year period has seen an unpleasant 56% overall drop in EPS. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
In contrast to the company, the rest of the market is expected to grow by 23% over the next year, which really puts the company's recent medium-term earnings decline into perspective.
In light of this, it's understandable that China 21st Century Education Group's P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. Even just maintaining these prices could be difficult to achieve as recent earnings trends are already weighing down the shares.
The Final Word
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 China 21st Century Education Group revealed its shrinking earnings over the medium-term are contributing to its low P/E, given the market is set to grow. 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 moving strongly in either direction in the near future under these circumstances.
We don't want to rain on the parade too much, but we did also find 4 warning signs for China 21st Century Education Group (2 shouldn't be ignored!) that you need to be mindful of.
You might be able to find a better investment than China 21st Century Education Group. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).
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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.