Hongbo Co.,Ltd. (SZSE:002229) shares have had a horrible month, losing 27% after a relatively good period beforehand. The last month has meant the stock is now only up 5.5% during the last year.

Even after such a large drop in price, given around half the companies in China's Commercial Services industry have price-to-sales ratios (or "P/S") below 2.6x, you may still consider HongboLtd as a stock to avoid entirely with its 14.8x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Has HongboLtd Performed Recently?

Revenue has risen firmly for HongboLtd recently, which is pleasing to see. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For HongboLtd?

In order to justify its P/S ratio, HongboLtd would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered a decent 14% gain to the company's revenues. The latest three year period has also seen an excellent 31% 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.

This is in contrast to the rest of the industry, which is expected to grow by 31% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that HongboLtd's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 HongboLtd's P/S?

HongboLtd's shares may have suffered, but its P/S remains high. 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 HongboLtd 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. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely to support such positive sentiment for long. Unless there is a significant improvement in the company's medium-term performance, 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 2 warning signs with HongboLtd (at least 1 which doesn't sit too well with us), and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on HongboLtd, explore our interactive list of high quality stocks to get an idea of what else is out there.

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.