China General Education Group Limited's (HKG:2175) price-to-earnings (or "P/E") ratio of 5.6x might make it look like a buy right now compared to the market in Hong Kong, where around half of the companies have P/E ratios above 10x and even P/E's above 19x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's limited.
As an illustration, earnings have deteriorated at China General Education Group over the last year, which is not ideal at all. One possibility is that the P/E is low because investors think the company won't do enough to avoid underperforming the broader market in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.
View our latest analysis for China General Education Group
What Are Growth Metrics Telling Us About The Low P/E?
There's an inherent assumption that a company should underperform the market for P/E ratios like China General Education Group's to be considered reasonable.
Retrospectively, the last year delivered a frustrating 22% decrease to the company's bottom line. This means it has also seen a slide in earnings over the longer-term as EPS is down 35% in total over the last three years. Therefore, it's fair to say the earnings growth recently has been undesirable for the company.
Comparing that to the market, which is predicted to deliver 22% growth in the next 12 months, the company's downward momentum based on recent medium-term earnings results is a sobering picture.
With this information, we are not surprised that China General Education Group is trading at a P/E lower than the market. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.
The Bottom Line On China General Education Group'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 General Education Group maintains its low P/E on the weakness of its sliding earnings over the medium-term, 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 the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.
It is also worth noting that we have found 3 warning signs for China General Education Group (1 shouldn't be ignored!) that you need to take into consideration.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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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.