Hualan Group Co., Ltd. (SZSE:301027) shareholders that were waiting for something to happen have been dealt a blow with a 28% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 38% share price drop.

In spite of the heavy fall in price, when almost half of the companies in China's Construction industry have price-to-sales ratios (or "P/S") below 1.1x, you may still consider Hualan Group as a stock probably not worth researching with its 1.8x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

What Does Hualan Group's P/S Mean For Shareholders?

For instance, Hualan Group's receding revenue in recent times would have to be some food for thought. 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

What Are Revenue Growth Metrics Telling Us About The High P/S?

Hualan Group's P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 21%. This means it has also seen a slide in revenue over the longer-term as revenue is down 32% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 26% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Hualan Group's P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Hualan Group's P/S remain high even after its stock plunged. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Hualan Group 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.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Hualan Group (2 are potentially serious) you should be aware of.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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