The Huabao International Holdings Limited (HKG:336) share price has done very well over the last month, posting an excellent gain of 26%. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 20% in the last twelve months.

Following the firm bounce in price, given around half the companies in Hong Kong's Chemicals industry have price-to-sales ratios (or "P/S") below 0.4x, you may consider Huabao International Holdings as a stock to avoid entirely with its 2.5x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Huabao International Holdings Has Been Performing

As an illustration, revenue has deteriorated at Huabao International Holdings over the last year, which is not ideal at all. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. 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?

The only time you'd be truly comfortable seeing a P/S as steep as Huabao International Holdings' is when the company's growth is on track to outshine the industry decidedly.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 14%. The last three years don't look nice either as the company has shrunk revenue by 14% in aggregate. 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 45% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Huabao International Holdings' P/S sits above the majority of other companies. 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. 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 Final Word

The strong share price surge has lead to Huabao International Holdings' P/S soaring as well. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Huabao International Holdings 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. 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 1 warning sign for Huabao International Holdings that we have uncovered.

If these risks are making you reconsider your opinion on Huabao International Holdings, 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.