Hunan Hengguang Technology Co., Ltd.'s (SZSE:301118) price-to-sales (or "P/S") ratio of 1.8x might make it look like a buy right now compared to the Chemicals industry in China, where around half of the companies have P/S ratios above 2.4x and even P/S above 5x are quite common. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

What Does Hunan Hengguang Technology's P/S Mean For Shareholders?

Hunan Hengguang Technology has been doing a good job lately as it's been growing revenue at a solid pace. One possibility is that the P/S is low because investors think this respectable revenue growth might actually underperform the broader industry in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

How Is Hunan Hengguang Technology's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as low as Hunan Hengguang Technology's is when the company's growth is on track to lag the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 22%. The strong recent performance means it was also able to grow revenue by 40% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 25% shows it's noticeably less attractive.

With this information, we can see why Hunan Hengguang Technology is trading at a P/S lower than the industry. It seems most investors are expecting to see the recent limited growth rates continue into the future and are only willing to pay a reduced amount for the stock.

The Final Word

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.

In line with expectations, Hunan Hengguang Technology maintains its low P/S on the weakness of its recent three-year growth being lower than the wider industry forecast. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

It is also worth noting that we have found 2 warning signs for Hunan Hengguang Technology (1 makes us a bit uncomfortable!) that you need to take into consideration.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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