China Xinhua Education Group Limited (HKG:2779) Shares Fly 31% But Investors Aren't Buying For Growth

China Xinhua Education Group Limited (HKG:2779) shareholders would be excited to see that the share price has had a great month, posting a 31% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 31% over that time.

Even after such a large jump in price, China Xinhua Education Group's price-to-earnings (or "P/E") ratio of 4.1x might still make it look like a strong buy right now compared to the market in Hong Kong, where around half of the companies have P/E ratios above 9x and even P/E's above 18x 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 so limited.

As an illustration, earnings have deteriorated at China Xinhua 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.

See our latest analysis for China Xinhua Education Group

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How Is China Xinhua Education Group's Growth Trending?

The only time you'd be truly comfortable seeing a P/E as depressed as China Xinhua Education Group's is when the company's growth is on track to lag the market decidedly.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 23%. As a result, earnings from three years ago have also fallen 9.8% overall. 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 24% 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 Xinhua 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. There's potential for the P/E to fall to even lower levels if the company doesn't improve its profitability.

What We Can Learn From China Xinhua Education Group's P/E?

Even after such a strong price move, China Xinhua Education Group's P/E still trails the rest of the market significantly. It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that China Xinhua 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. 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.

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

If you're unsure about the strength of China Xinhua Education Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.