Hengfeng Information Technology Co., Ltd. (SZSE:300605) shares have had a really impressive month, gaining 30% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 25% in the last twelve months.

Following the firm bounce in price, given close to half the companies operating in China's IT industry have price-to-sales ratios (or "P/S") below 3.3x, you may consider Hengfeng Information Technology as a stock to potentially avoid with its 4.2x 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.

How Hengfeng Information Technology Has Been Performing

For instance, Hengfeng Information Technology's receding revenue in recent times would have to be some food for thought. 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. 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?

The only time you'd be truly comfortable seeing a P/S as high as Hengfeng Information Technology's is when the company's growth is on track to outshine the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 16%. This means it has also seen a slide in revenue over the longer-term as revenue is down 14% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 27% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Hengfeng Information Technology's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Final Word

The large bounce in Hengfeng Information Technology's shares has lifted the company's P/S handsomely. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've established that Hengfeng Information Technology currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

Plus, you should also learn about these 5 warning signs we've spotted with Hengfeng Information Technology (including 3 which are concerning).

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.

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