A Rising Share Price Has Us Looking Closely At China New Higher Education Group Limited's (HKG:2001) P/E Ratio
China New Higher Education Group (HKG:2001) shareholders are no doubt pleased to see that the share price has had a great month, posting a 30% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 15% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
View our latest analysis for China New Higher Education Group
Does China New Higher Education Group Have A Relatively High Or Low P/E For Its Industry?
China New Higher Education Group's P/E of 11.21 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (13.1) for companies in the consumer services industry is higher than China New Higher Education Group's P/E.
Its relatively low P/E ratio indicates that China New Higher Education Group shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
China New Higher Education Group's earnings made like a rocket, taking off 51% last year. And earnings per share have improved by 39% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does China New Higher Education Group's Balance Sheet Tell Us?
China New Higher Education Group has net debt worth just 9.5% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On China New Higher Education Group's P/E Ratio
China New Higher Education Group has a P/E of 11.2. That's higher than the average in its market, which is 9.5. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable. What we know for sure is that investors have become more excited about China New Higher Education Group recently, since they have pushed its P/E ratio from 8.6 to 11.2 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than China New Higher Education Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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