Shanghai Shenda Co., Ltd (SHSE:600626) shares have had a horrible month, losing 26% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 12% share price drop.

Even after such a large drop in price, it's still not a stretch to say that Shanghai Shenda's price-to-sales (or "P/S") ratio of 0.4x right now seems quite "middle-of-the-road" compared to the Retail Distributors industry in China, where the median P/S ratio is around 0.6x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

Check out our latest analysis for Shanghai Shenda

How Shanghai Shenda Has Been Performing

Shanghai Shenda has been doing a good job lately as it's been growing revenue at a solid pace. It might be that many expect the respectable revenue performance to wane, which has kept the P/S from rising. Those who are bullish on Shanghai Shenda will be hoping that this isn't the case, so that they can pick up the stock at a lower valuation.

What Are Revenue Growth Metrics Telling Us About The P/S?

There's an inherent assumption that a company should be matching the industry for P/S ratios like Shanghai Shenda's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 15% gain to the company's top line. However, this wasn't enough as the latest three year period has seen the company endure a nasty 4.6% drop in revenue in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenues over that time.

In contrast to the company, the rest of the industry is expected to grow by 18% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Shanghai Shenda is trading at a fairly similar P/S compared to the industry. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh on the share price eventually.

The Key Takeaway

With its share price dropping off a cliff, the P/S for Shanghai Shenda looks to be in line with the rest of the Retail Distributors industry. 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 look at Shanghai Shenda revealed its shrinking revenues over the medium-term haven't impacted the P/S as much as we anticipated, given the industry is set to grow. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. 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.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Shanghai Shenda (of which 2 can't be ignored!) you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.