Shang Gong Group Co., Ltd. (SHSE:600843) shares have continued their recent momentum with a 25% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 51% in the last year.

Although its price has surged higher, Shang Gong Group's price-to-sales (or "P/S") ratio of 1.5x might still make it look like a buy right now compared to the Machinery industry in China, where around half of the companies have P/S ratios above 2.4x and even P/S above 5x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/S.

What Does Shang Gong Group's P/S Mean For Shareholders?

Revenue has risen firmly for Shang Gong Group recently, which is pleasing to see. Perhaps the market is expecting this acceptable revenue performance to take a dive, which has kept the P/S suppressed. Those who are bullish on Shang Gong Group will be hoping that this isn't the case, so that they can pick up the stock at a lower valuation.

How Is Shang Gong Group's Revenue Growth Trending?

There's an inherent assumption that a company should underperform the industry for P/S ratios like Shang Gong Group's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 17% last year. As a result, it also grew revenue by 27% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been respectable for the company.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 22% shows it's noticeably less attractive.

With this information, we can see why Shang Gong Group is trading at a P/S lower than the industry. It seems most investors are expecting to see the recent limited growth rates continue into the future and are only willing to pay a reduced amount for the stock.

The Key Takeaway

Shang Gong Group's stock price has surged recently, but its but its P/S still remains modest. 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.

As we suspected, our examination of Shang Gong Group revealed its three-year revenue trends are contributing to its low P/S, given they look worse than current industry expectations. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

It is also worth noting that we have found 3 warning signs for Shang Gong Group (2 are a bit unpleasant!) that you need to take into consideration.

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.

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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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