Shanghai Sunglow Packaging Technology Co.,Ltd (SHSE:603499) shares have retraced a considerable 25% in the last month, reversing a fair amount of their solid recent performance. Of course, over the longer-term many would still wish they owned shares as the stock's price has soared 106% in the last twelve months.

Even after such a large drop in price, you could still be forgiven for thinking Shanghai Sunglow Packaging TechnologyLtd is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 5.6x, considering almost half the companies in China's Packaging industry have P/S ratios below 1.7x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Shanghai Sunglow Packaging TechnologyLtd Has Been Performing

The revenue growth achieved at Shanghai Sunglow Packaging TechnologyLtd over the last year would be more than acceptable for most companies. 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

Shanghai Sunglow Packaging TechnologyLtd's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Retrospectively, the last year delivered a decent 8.4% gain to the company's revenues. The latest three year period has also seen an excellent 68% overall rise in revenue, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing revenues over that time.

It's interesting to note that the rest of the industry is similarly expected to grow by 19% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.

With this in mind, we find it intriguing that Shanghai Sunglow Packaging TechnologyLtd's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as a continuation of recent revenue trends would weigh down the share price eventually.

The Final Word

Shanghai Sunglow Packaging TechnologyLtd's shares may have suffered, but its P/S remains high. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Shanghai Sunglow Packaging TechnologyLtd revealed its three-year revenue trends aren't impacting its high P/S as much as we would have predicted, given they look similar to current industry expectations. When we see average revenue with industry-like growth combined with a high P/S, we suspect the share price is at risk of declining, bringing the P/S back in line with the industry too. Unless there is a significant improvement in the company's medium-term trends, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Shanghai Sunglow Packaging TechnologyLtd (at least 2 which don't sit too well with us), and understanding them should be part of your investment process.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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.