Shenzhen GuoHua Network Security Technology Co., Ltd. (SZSE:000004) shares have continued their recent momentum with a 28% gain in the last month alone. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

After such a large jump in price, when almost half of the companies in China's Software industry have price-to-sales ratios (or "P/S") below 7.4x, you may consider Shenzhen GuoHua Network Security Technology as a stock not worth researching with its 24.3x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Shenzhen GuoHua Network Security Technology Has Been Performing

For example, consider that Shenzhen GuoHua Network Security Technology's financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. If not, then existing shareholders may be quite nervous about the viability of the share price.

How Is Shenzhen GuoHua Network Security Technology's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as steep as Shenzhen GuoHua Network Security Technology's is when the company's growth is on track to outshine the industry decidedly.

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 65% 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 33% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Shenzhen GuoHua Network Security Technology's P/S exceeds that of its industry peers. 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.

What We Can Learn From Shenzhen GuoHua Network Security Technology's P/S?

The strong share price surge has lead to Shenzhen GuoHua Network Security Technology's P/S soaring as well. 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 Shenzhen GuoHua Network Security Technology 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. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

It is also worth noting that we have found 2 warning signs for Shenzhen GuoHua Network Security Technology that you need to take into consideration.

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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