Chinese Education Stocks Surge into Year End

The financial markets tend to move in cycles. Prior to this year, domestic equities served as a top-performing asset class dating back to the Great Recession. The historic bull market that began in…

Chinese Education Stocks Surge into Year End

The financial markets tend to move in cycles. Prior to this year, domestic equities served as a top-performing asset class dating back to the Great Recession. The historic bull market that began in early 2009 saw many U.S.-based companies experience stellar returns in the years that followed. These companies really flourished and handily outperformed their Asian counterparts. In fact, as we can see below, large-cap U.S. stocks dominated emerging market equities over the last decade.

Image Source: StockCharts

While it's still too early to call a true bottom in this ratio, we are beginning to see signs of emerging market equities turning the page on the last decade plus of underperformance. When we take a step back and examine the historical returns more deeply, we find that emerging market stocks have certainly had their own periods of outperformance. And while emerging markets have underperformed in the recent past, as we'll see, the signs are there that these foreign equities are beginning to turn the page to the next chapter.

Emerging market valuations are very attractive. In particular, many Chinese companies (and their stocks) were hit hard due to extensive COVID-19 related measures, along with regulatory and technology crackdowns in recent years. This has created great value propositions, with many emerging market stocks becoming appealing once again. As China continues to lift lockdown restrictions and eases up on some of the more assertive regulations, the Chinese equities that have been hated by investors will soon become loved.

When targeting stocks for our portfolio, we want to focus on companies that are leading the pack and displaying signs of outperformance. Many Chinese stocks appear to have bottomed out all the way back in March, and these companies are leading the charge. And as China eases up on their stringent COVID policies, there's plenty of reasons to believe the run-up in these stocks may be just getting started.

One Chinese education company that is showing relative strength is New Oriental Education and Technology Group EDU, a Zacks Rank #2 (Buy) stock. This company fell victim to the broad decline in Chinese equities over the past year. This has presented a unique opportunity, as shares became underappreciated.

EDU is a component of the Zacks Schools industry group, which currently ranks in the top 35% out of approximately 250 industries. Because it is ranked in the top half of all Zacks Ranked Industries, we expect this group to outperform the market over the next 3 to 6 months.

Historical research studies suggest that approximately half of a stock's future price appreciation is due to its industry grouping. In fact, the top 50% of Zacks Ranked Industries outperforms the bottom 50% by a factor of more than 2 to 1. By targeting stocks contained within the top industry groups, we can dramatically improve our odds of success.

Also note the relative outperformance for this industry as well as favorable metrics below:

Image Source: Zacks Investment Research

Image Source: Zacks Investment Research

Let's take a closer look at this top-ranked stock.

Company Description

New Oriental Education & Technology Group provides private educational services in China. EDU offers test preparation courses, non-academic tutoring courses, intelligent learning systems, and overseas consulting services. Its online education platform through provides comprehensive education courses to schools and institutional customers, universities, libraries, and online video streaming providers.

Over the past few years, there have been talks that Chinese firms would be delisted from U.S. stock exchanges due to a lack of transparency regarding Chinese accounting practices. But back in August, American and Chinese regulators reached an agreement to allow accounting firms in China to share more information about the companies listed on U.S. exchanges. The agreement marked a turning point in resolving a major conflict that had originally pointed to a departure of China's largest companies from domestic exchanges.

Positive Trend in Earnings Estimates

Analysts covering EDU increased earnings estimates across the board for both the current fiscal year and next year. This year, estimates have risen 200% in the past 60 days. The fiscal ‘23 Zacks Consensus Estimate now stands at $0.48/share, reflecting growth of 177.42% relative to last year.

Looking out at next year, analysts have bumped up EPS estimates by 196.55% in the past 60 days. The fiscal ‘24 Zacks Consensus Estimate is now $0.86/share, translating to potential growth of 79.17% versus this year, with sales anticipated to climb 14.49% to $2.59 billion. At a time when many companies are seeing earnings estimates fall, this company is standing out above the rest.

Image Source: Zacks Investment Research

Stock Price Movement

EDU shares bottomed out at $8.64/share all the way back in March – well before the major U.S. indices. The stock has more than quadrupled since then and is showing no signs of slowing down. Only stocks in the most powerful uptrends are able to experience this type of outperformance while the market continues to hover in a deep correction. Also note how both the 50-day and 200-day moving averages (as illustrated by the blue and red lines, respectively) have turned up:

Image Source: StockCharts

Empirical research shows a strong correlation between near-term stock movements and trends in earnings estimate revisions. And as we know, EDU has recently witnessed positive revisions. As long as this trend remains intact (and EDU continues to deliver earnings beats), the stock will likely continue its bullish run into next year.

Bottom Line

As in 2022, stock selection will be crucial to performance in 2023. Backed by a leading industry group and a history of earnings beats, it's not difficult to see why this company is a compelling investment.

While large-cap U.S. stocks dominated the returns over the last decade, emerging market equities are ripe for a period of outperformance. Investors would be wise to consider this high-growth, high-momentum stock into the new year.

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