Ruihe Data Technology Holdings Limited (HKG:3680) shareholders that were waiting for something to happen have been dealt a blow with a 25% share price drop in the last month. Looking at the bigger picture, even after this poor month the stock is up 58% in the last year.

Although its price has dipped substantially, you could still be forgiven for thinking Ruihe Data Technology Holdings is a stock not worth researching with a price-to-sales ratios (or "P/S") of 2x, considering almost half the companies in Hong Kong's IT industry have P/S ratios below 1.3x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

How Has Ruihe Data Technology Holdings Performed Recently?

As an illustration, revenue has deteriorated at Ruihe Data Technology Holdings over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Ruihe Data Technology Holdings would need to produce impressive growth in excess of the industry.

Retrospectively, the last year delivered a frustrating 2.4% decrease to the company's top line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 11% overall rise in revenue. 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 14% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Ruihe Data Technology Holdings' P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates 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

Despite the recent share price weakness, Ruihe Data Technology Holdings' P/S remains higher than most other companies in the industry. 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.

Our examination of Ruihe Data Technology Holdings revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

There are also other vital risk factors to consider and we've discovered 2 warning signs for Ruihe Data Technology Holdings (1 doesn't sit too well with us!) that you should be aware of before investing here.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.