China New City Group Limited (HKG:1321) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 23% over that time.

Since its price has surged higher, you could be forgiven for thinking China New City Group is a stock not worth researching with a price-to-sales ratios (or "P/S") of 1.3x, considering almost half the companies in Hong Kong's Real Estate industry have P/S ratios below 0.6x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

How China New City Group Has Been Performing

China New City Group certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. The P/S ratio is probably high because investors think this strong revenue growth will be enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For China New City Group?

In order to justify its P/S ratio, China New City Group would need to produce impressive growth in excess of the industry.

Taking a look back first, we see that the company grew revenue by an impressive 98% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 28% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 7.5% shows it's an unpleasant look.

With this information, we find it concerning that China New City Group is trading at a P/S higher than the industry. 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

China New City Group's P/S is on the rise since its shares have risen strongly. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of China New City Group revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

You should always think about risks. Case in point, we've spotted 3 warning signs for China New City Group you should be aware of, and 2 of them don't sit too well with us.

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.