China Graphite Group Limited (HKG:2237) shares have had a really impressive month, gaining 30% after a shaky period beforehand. Still, the 30-day jump doesn't change the fact that longer term shareholders have seen their stock decimated by the 68% share price drop in the last twelve months.

Since its price has surged higher, given around half the companies in Hong Kong's Metals and Mining industry have price-to-sales ratios (or "P/S") below 0.5x, you may consider China Graphite Group as a stock to avoid entirely with its 3.8x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

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

For instance, China Graphite 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

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

Retrospectively, the last year delivered a frustrating 26% decrease to the company's top line. That put a dampener on the good run it was having over the longer-term as its three-year revenue growth is still a noteworthy 20% in total. So we can start by confirming that the company has generally done a good job of growing revenue over that time, even though it had some hiccups along the way.

This is in contrast to the rest of the industry, which is expected to grow by 12% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that China Graphite 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 good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What Does China Graphite Group's P/S Mean For Investors?

China Graphite Group's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

The fact that China Graphite Group currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

Having said that, be aware China Graphite Group is showing 2 warning signs in our investment analysis, you should know about.

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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