Virscend Education Company Limited (HKG:1565) shareholders have had their patience rewarded with a 31% share price jump in the last month. Taking a wider view, although not as strong as the last month, the full year gain of 20% is also fairly reasonable.

Since its price has surged higher, given close to half the companies in Hong Kong have price-to-earnings ratios (or "P/E's") below 9x, you may consider Virscend Education as a stock to avoid entirely with its 13.7x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so lofty.

Virscend Education certainly has been doing a great job lately as it's been growing earnings at a really rapid pace. The P/E is probably high because investors think this strong earnings growth will be enough to outperform the broader market in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

View our latest analysis for Virscend Education

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as steep as Virscend Education's is when the company's growth is on track to outshine the market decidedly.

Taking a look back first, we see that the company grew earnings per share by an impressive 185% last year. Still, incredibly EPS has fallen 90% in total from three years ago, which is quite disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.

Comparing that to the market, which is predicted to deliver 24% 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 find it concerning that Virscend Education is trading at a P/E higher than the market. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Shares in Virscend Education have built up some good momentum lately, which has really inflated its P/E. 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.

Our examination of Virscend Education revealed its shrinking earnings over the medium-term aren't impacting its high P/E anywhere near as much as we would have predicted, given the market is set to grow. When we see earnings heading backwards and underperforming the market forecasts, we suspect the share price is at risk of declining, sending the high P/E lower. If recent medium-term earnings trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You need to take note of risks, for example - Virscend Education has 3 warning signs (and 2 which make us uncomfortable) we think you should know about.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.