What Kip McGrath Education Centres Limited's (ASX:KME) 27% Share Price Gain Is Not Telling You

Kip McGrath Education Centres Limited (ASX:KME) shares have continued their recent momentum with a 27% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 37% in the last year.

Following the firm bounce in price, Kip McGrath Education Centres' price-to-earnings (or "P/E") ratio of 38.5x might make it look like a strong sell right now compared to the market in Australia, where around half of the companies have P/E ratios below 20x and even P/E's below 11x 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 lofty.

For instance, Kip McGrath Education Centres' receding earnings in recent times would have to be some food for thought. One possibility is that the P/E is high because investors think the company will still do 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 Kip McGrath Education Centres

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Kip McGrath Education Centres' earnings, revenue and cash flow.

How Is Kip McGrath Education Centres' Growth Trending?

Kip McGrath Education Centres' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.

Retrospectively, the last year delivered a frustrating 41% decrease to the company's bottom line. That put a dampener on the good run it was having over the longer-term as its three-year EPS growth is still a noteworthy 8.0% in total. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of earnings growth.

Comparing that to the market, which is predicted to deliver 22% growth in the next 12 months, the company's momentum is weaker based on recent medium-term annualised earnings results.

With this information, we find it concerning that Kip McGrath Education Centres is trading at a P/E higher than the market. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/E falls to levels more in line with recent growth rates.

The Bottom Line On Kip McGrath Education Centres' P/E

Kip McGrath Education Centres' P/E is flying high just like its stock has during the last month. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.

Our examination of Kip McGrath Education Centres revealed its three-year earnings trends aren't impacting its high P/E anywhere near as much as we would have predicted, given they look worse than current market expectations. When we see weak earnings with slower than market growth, 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.

Before you take the next step, you should know about the 6 warning signs for Kip McGrath Education Centres (1 is significant!) that we have uncovered.

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

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. 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.

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