When you see that almost half of the companies in the Professional Services industry in China have price-to-sales ratios (or "P/S") below 3x, HCR Co., Ltd (SHSE:688500) looks to be giving off some sell signals with its 4.6x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does HCR's P/S Mean For Shareholders?

The recent revenue growth at HCR would have to be considered satisfactory if not spectacular. It might be that many expect the reasonable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For HCR?

In order to justify its P/S ratio, HCR would need to produce impressive growth in excess of the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 5.3%. The latest three year period has also seen an excellent 39% overall rise in revenue, aided somewhat by its short-term performance. 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 97% shows it's noticeably less attractive.

With this in mind, we find it worrying that HCR's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates 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 recent growth rates.

What Does HCR's P/S Mean For Investors?

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.

Our examination of HCR revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You always need to take note of risks, for example - HCR has 1 warning sign we think 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).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.