China Modern Dairy Holdings Ltd. (HKG:1117) shareholders have had their patience rewarded with a 26% share price jump in the last month. Notwithstanding the latest gain, the annual share price return of 8.8% isn't as impressive.

Although its price has surged higher, you could still be forgiven for feeling indifferent about China Modern Dairy Holdings' P/S ratio of 0.5x, since the median price-to-sales (or "P/S") ratio for the Food industry in Hong Kong is about the same. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

How Has China Modern Dairy Holdings Performed Recently?

The recently shrinking revenue for China Modern Dairy Holdings has been in line with the industry. Perhaps the market is expecting future revenue performance to continue matching the industry, which has kept the P/S in line with expectations. You'd much rather the company improve its revenue if you still believe in the business. In saying that, existing shareholders probably aren't too pessimistic about the share price if the company's revenue continues tracking the industry.

How Is China Modern Dairy Holdings' Revenue Growth Trending?

In order to justify its P/S ratio, China Modern Dairy Holdings would need to produce growth that's similar to the industry.

Retrospectively, the last year delivered virtually the same number to the company's top line as the year before. Although pleasingly revenue has lifted 108% in aggregate from three years ago, notwithstanding the last 12 months. So while the company has done a solid job in the past, it's somewhat concerning to see revenue growth decline as much as it has.

Turning to the outlook, the next year should generate growth of 4.3% as estimated by the seven analysts watching the company. That's shaping up to be materially lower than the 6.6% growth forecast for the broader industry.

With this information, we find it interesting that China Modern Dairy Holdings is trading at a fairly similar P/S compared to the industry. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Key Takeaway

China Modern Dairy Holdings appears to be back in favour with a solid price jump bringing its P/S back in line with other companies in the industry 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.

When you consider that China Modern Dairy Holdings' revenue growth estimates are fairly muted compared to the broader industry, it's easy to see why we consider it unexpected to be trading at its current P/S ratio. At present, we aren't confident in the P/S as the predicted future revenues aren't likely to support a more positive sentiment for long. Circumstances like this present a risk to current and prospective investors who may see share prices fall if the low revenue growth impacts the sentiment.

Before you settle on your opinion, we've discovered 1 warning sign for China Modern Dairy Holdings that you should be aware of.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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.