China Zhonghua Geotechnical Engineering Group Co., Ltd. (SZSE:002542) shareholders that were waiting for something to happen have been dealt a blow with a 29% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 43% share price drop.

In spite of the heavy fall in price, it's still not a stretch to say that China Zhonghua Geotechnical Engineering Group's price-to-sales (or "P/S") ratio of 1.4x right now seems quite "middle-of-the-road" compared to the Construction industry in China, where the median P/S ratio is around 1.1x. Although, it's not wise to simply ignore the P/S without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

How China Zhonghua Geotechnical Engineering Group Has Been Performing

For instance, China Zhonghua Geotechnical Engineering Group's receding revenue in recent times would have to be some food for thought. One possibility is that the P/S is moderate because investors think the company might still do enough to be in line with the broader industry in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

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 China Zhonghua Geotechnical Engineering Group's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 16%. This means it has also seen a slide in revenue over the longer-term as revenue is down 49% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 25% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that China Zhonghua Geotechnical Engineering Group'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 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 Final Word

Following China Zhonghua Geotechnical Engineering Group's share price tumble, its P/S is just clinging on to the industry median P/S. 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 China Zhonghua Geotechnical Engineering Group 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. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with China Zhonghua Geotechnical Engineering Group (at least 2 which can't be ignored), and understanding them should be part of your investment process.

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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