Further Upside For China Education Group Holdings Limited (HKG:839) Shares Could Introduce Price Risks After 25% Bounce

China Education Group Holdings Limited (HKG:839) shareholders would be excited to see that the share price has had a great month, posting a 25% gain and recovering from prior weakness. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

In spite of the firm bounce in price, China Education Group Holdings' price-to-earnings (or "P/E") ratio of 8.7x might still 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 13x and even P/E's above 24x are quite common. However, the P/E might be low for a reason and it requires further investigation to determine if it's justified.

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Recent times have been advantageous for China Education Group Holdings as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. 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.

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Does Growth Match The Low P/E?

There's an inherent assumption that a company should underperform the market for P/E ratios like China Education Group Holdings' to be considered reasonable.

Taking a look back first, we see that the company grew earnings per share by an impressive 120% last year. Still, incredibly EPS has fallen 55% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Shifting to the future, estimates from the seven analysts covering the company suggest earnings should grow by 29% per annum over the next three years. That's shaping up to be materially higher than the 14% each year growth forecast for the broader market.

With this information, we find it odd that China Education Group Holdings is trading at a P/E lower than the market. Apparently some shareholders are doubtful of the forecasts and have been accepting significantly lower selling prices.

The Final Word

Despite China Education Group Holdings' shares building up a head of steam, its P/E still lags most other companies. 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 Education Group Holdings currently trades on a much lower than expected P/E since its forecast growth is higher than the wider market. There could be some major unobserved threats to earnings preventing the P/E ratio from matching the positive outlook. It appears many are indeed anticipating earnings instability, because these conditions should normally provide a boost to the share price.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for China Education Group Holdings that you should be aware of.

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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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.