To the annoyance of some shareholders, Grace Life-tech Holdings Limited (HKG:2112) shares are down a considerable 26% in the last month, which continues a horrid run for the company. The recent drop completes a disastrous twelve months for shareholders, who are sitting on a 61% loss during that time.

In spite of the heavy fall in price, when almost half of the companies in Hong Kong's Trade Distributors industry have price-to-sales ratios (or "P/S") below 0.6x, you may still consider Grace Life-tech Holdings as a stock probably not worth researching with its 1.8x 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 as high as it is.

View our latest analysis for Grace Life-tech Holdings

What Does Grace Life-tech Holdings' Recent Performance Look Like?

For instance, Grace Life-tech Holdings' 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

Grace Life-tech Holdings' P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than 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 32%. The last three years don't look nice either as the company has shrunk revenue by 88% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 3.5% shows it's an unpleasant look.

In light of this, it's alarming that Grace Life-tech Holdings' 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. 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

There's still some elevation in Grace Life-tech Holdings' P/S, even if the same can't be said for its share price recently. 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 Grace Life-tech Holdings 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Grace Life-tech Holdings (at least 2 which are potentially serious), and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Grace Life-tech Holdings, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.