To the annoyance of some shareholders, Shenzhen Ecobeauty Co., Ltd. (SZSE:000010) shares are down a considerable 25% in the last month, which continues a horrid run for the company. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 30% in that time.

Although its price has dipped substantially, given around half the companies in China's Commercial Services industry have price-to-sales ratios (or "P/S") below 2.7x, you may still consider Shenzhen Ecobeauty as a stock to avoid entirely with its 9.3x 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.

What Does Shenzhen Ecobeauty's Recent Performance Look Like?

For instance, Shenzhen Ecobeauty's receding revenue in recent times would have to be some food for thought. 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. 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?

In order to justify its P/S ratio, Shenzhen Ecobeauty would need to produce outstanding growth that's well in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 76%. The last three years don't look nice either as the company has shrunk revenue by 81% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 30% 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 Shenzhen Ecobeauty is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

The Bottom Line On Shenzhen Ecobeauty's P/S

Shenzhen Ecobeauty's shares may have suffered, but its P/S remains high. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that Shenzhen Ecobeauty currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Shenzhen Ecobeauty that you should be aware of.

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.