Those holding Hangzhou Wensli Silk Culture Co., Ltd. (SZSE:301066) shares would be relieved that the share price has rebounded 34% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 19% in the last twelve months.

Following the firm bounce in price, you could be forgiven for thinking Hangzhou Wensli Silk Culture is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.1x, considering almost half the companies in China's Luxury industry have P/S ratios below 1.7x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Hangzhou Wensli Silk Culture Has Been Performing

Revenue has risen firmly for Hangzhou Wensli Silk Culture recently, which is pleasing to see. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

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

Taking a look back first, we see that the company managed to grow revenues by a handy 11% last year. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 14% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Comparing that to the industry, which is predicted to deliver 19% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Hangzhou Wensli Silk Culture'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 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 Hangzhou Wensli Silk Culture's P/S

Hangzhou Wensli Silk Culture shares have taken a big step in a northerly direction, but its P/S is elevated as a result. 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 Hangzhou Wensli Silk Culture 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. 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.

You should always think about risks. Case in point, we've spotted 4 warning signs for Hangzhou Wensli Silk Culture you should be aware of, and 1 of them is a bit unpleasant.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.