Despite an already strong run, Dalian Friendship (Group) Co., Ltd. (SZSE:000679) shares have been powering on, with a gain of 26% in the last thirty days. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 42% over that time.
Since its price has surged higher, when almost half of the companies in China's Multiline Retail industry have price-to-sales ratios (or "P/S") below 1.4x, you may consider Dalian Friendship (Group) as a stock not worth researching with its 7.8x 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 so lofty.
How Dalian Friendship (Group) Has Been Performing
Dalian Friendship (Group) 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.
Although there are no analyst estimates available for Dalian Friendship (Group), take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.
Do Revenue Forecasts Match The High P/S Ratio?
Dalian Friendship (Group)'s P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.
If we review the last year of revenue growth, the company posted a worthy increase of 4.2%. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 19% 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.
Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 15% shows it's an unpleasant look.
In light of this, it's alarming that Dalian Friendship (Group)'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 strong share price surge has lead to Dalian Friendship (Group)'s P/S soaring as well. 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.
We've established that Dalian Friendship (Group) 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.
And what about other risks? Every company has them, and we've spotted 1 warning sign for Dalian Friendship (Group) you should know about.
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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