Zhaobangji Lifestyle Holdings Limited (HKG:1660) shareholders won't be pleased to see that the share price has had a very rough month, dropping 26% and undoing the prior period's positive performance. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 41% share price drop.

Even after such a large drop in price, when almost half of the companies in Hong Kong's Trade Distributors industry have price-to-sales ratios (or "P/S") below 0.4x, you may still consider Zhaobangji Lifestyle Holdings as a stock not worth researching with its 3.9x 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.

How Has Zhaobangji Lifestyle Holdings Performed Recently?

Zhaobangji Lifestyle Holdings has been doing a decent job lately as it's been growing revenue at a reasonable pace. Perhaps the market believes the recent revenue performance is strong enough to outperform the industry, which has inflated the P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as Zhaobangji Lifestyle Holdings' is when the company's growth is on track to outshine the industry decidedly.

If we review the last year of revenue growth, the company posted a worthy increase of 7.3%. Revenue has also lifted 22% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of revenue growth.

This is in contrast to the rest of the industry, which is expected to grow by 24% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Zhaobangji Lifestyle Holdings is trading at a P/S higher than the industry. 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. 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.

What Does Zhaobangji Lifestyle Holdings' P/S Mean For Investors?

Even after such a strong price drop, Zhaobangji Lifestyle Holdings' P/S still exceeds the industry median significantly. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Zhaobangji Lifestyle 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 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. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Zhaobangji Lifestyle Holdings (at least 1 which can't be ignored), and understanding them should be part of your investment process.

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.