The Shenzhen Hongtao Group Co.,Ltd. (SZSE:002325) share price has softened a substantial 31% over the previous 30 days, handing back much of the gains the stock has made lately. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 31% share price drop.

Although its price has dipped substantially, given around half the companies in China's Construction industry have price-to-sales ratios (or "P/S") below 1.1x, you may still consider Shenzhen Hongtao GroupLtd as a stock to avoid entirely with its 3.2x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

How Has Shenzhen Hongtao GroupLtd Performed Recently?

As an illustration, revenue has deteriorated at Shenzhen Hongtao GroupLtd over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do 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.

Is There Enough Revenue Growth Forecasted For Shenzhen Hongtao GroupLtd?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shenzhen Hongtao GroupLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 34% 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 79% 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 15% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Shenzhen Hongtao GroupLtd is trading at a P/S higher than the industry. 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 Key Takeaway

Even after such a strong price drop, Shenzhen Hongtao GroupLtd's P/S still exceeds the industry median significantly. 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 Shenzhen Hongtao GroupLtd 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shenzhen Hongtao GroupLtd, and understanding these should be part of your investment process.

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

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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.