Hunan HuashengCO.,Ltd (SHSE:600156) shareholders would be excited to see that the share price has had a great month, posting a 30% gain and recovering from prior weakness. Looking further back, the 22% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Following the firm bounce in price, you could be forgiven for thinking Hunan HuashengCO.Ltd is a stock not worth researching with a price-to-sales ratios (or "P/S") of 2.9x, considering almost half the companies in China's Luxury industry have P/S ratios below 1.7x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

What Does Hunan HuashengCO.Ltd's P/S Mean For Shareholders?

For example, consider that Hunan HuashengCO.Ltd's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Hunan HuashengCO.Ltd's Revenue Growth Trending?

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

Retrospectively, the last year delivered a frustrating 25% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 24% 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 19% 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 Hunan HuashengCO.Ltd's P/S exceeds that of its industry peers. 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

What We Can Learn From Hunan HuashengCO.Ltd's P/S?

The large bounce in Hunan HuashengCO.Ltd's shares has lifted the company's P/S handsomely. 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 examination of Hunan HuashengCO.Ltd revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. 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.

Before you take the next step, you should know about the 2 warning signs for Hunan HuashengCO.Ltd (1 is a bit unpleasant!) that we have uncovered.

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).

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.