Sportsoul Co.,Ltd. (SZSE:001300) shares have retraced a considerable 29% in the last month, reversing a fair amount of their solid recent performance. Indeed, the recent drop has reduced its annual gain to a relatively sedate 5.4% over the last twelve months.

Even after such a large drop in price, you could still be forgiven for thinking SportsoulLtd is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 11.7x, considering almost half the companies in China's Leisure industry have P/S ratios below 3.7x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for SportsoulLtd

How SportsoulLtd Has Been Performing

As an illustration, revenue has deteriorated at SportsoulLtd over the last year, which is not ideal at all. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For SportsoulLtd?

In order to justify its P/S ratio, SportsoulLtd would need to produce outstanding growth that's well in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 55%. This means it has also seen a slide in revenue over the longer-term as revenue is down 65% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 23% shows it's an unpleasant look.

With this in mind, we find it worrying that SportsoulLtd's P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Final Word

Even after such a strong price drop, SportsoulLtd's P/S still exceeds the industry median significantly. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that SportsoulLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

You always need to take note of risks, for example - SportsoulLtd has 2 warning signs we think you should be aware of.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.