Despite an already strong run, Zhejiang Lianxiang Smart Home Co., LTD (SHSE:603272) shares have been powering on, with a gain of 25% in the last thirty days. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 27% in the last twelve months.

Following the firm bounce in price, given around half the companies in China's Consumer Durables industry have price-to-sales ratios (or "P/S") below 1.9x, you may consider Zhejiang Lianxiang Smart Home as a stock to avoid entirely with its 10.7x 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 Zhejiang Lianxiang Smart Home's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Zhejiang Lianxiang Smart Home over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

Zhejiang Lianxiang Smart Home'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.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 35%. This means it has also seen a slide in revenue over the longer-term as revenue is down 57% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 9.6% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Zhejiang Lianxiang Smart Home is trading at a P/S higher than the industry. It seems most investors are ignoring the recent poor growth rate 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 Key Takeaway

The strong share price surge has lead to Zhejiang Lianxiang Smart Home's P/S soaring as well. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Zhejiang Lianxiang Smart Home revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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.

Before you settle on your opinion, we've discovered 2 warning signs for Zhejiang Lianxiang Smart Home that you should be aware of.

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.