When close to half the companies in the Commercial Services industry in Hong Kong have price-to-sales ratios (or "P/S") below 0.4x, you may consider ZONQING Environmental Limited (HKG:1855) as a stock to avoid entirely with its 2.9x 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.

What Does ZONQING Environmental's P/S Mean For Shareholders?

ZONQING Environmental certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. The P/S ratio is probably high because investors think this strong revenue growth will be 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 ZONQING Environmental?

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

Retrospectively, the last year delivered an exceptional 111% gain to the company's top line. Pleasingly, revenue has also lifted 135% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

This is in contrast to the rest of the industry, which is expected to grow by 6.2% over the next year, materially lower than the company's recent medium-term annualised growth rates.

In light of this, it's understandable that ZONQING Environmental's P/S sits above the majority of other companies. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the wider industry.

What We Can Learn From ZONQING Environmental's P/S?

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.

As we suspected, our examination of ZONQING Environmental revealed its three-year revenue trends are contributing to its high P/S, given they look better than current industry expectations. At this stage investors feel the potential continued revenue growth in the future is great enough to warrant an inflated P/S. Unless the recent medium-term conditions change, they will continue to provide strong support to the share price.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with ZONQING Environmental (at least 1 which is concerning), and understanding them should be part of your investment process.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.

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