Danhua Chemical Technology Co.,Ltd (SHSE:600844) shareholders have had their patience rewarded with a 28% share price jump in the last month. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

Since its price has surged higher, given close to half the companies operating in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2.4x, you may consider Danhua Chemical TechnologyLtd as a stock to potentially avoid with its 4x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

How Danhua Chemical TechnologyLtd Has Been Performing

As an illustration, revenue has deteriorated at Danhua Chemical TechnologyLtd 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Danhua Chemical TechnologyLtd?

In order to justify its P/S ratio, Danhua Chemical TechnologyLtd would need to produce impressive growth in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 3.1%. This means it has also seen a slide in revenue over the longer-term as revenue is down 35% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 26% shows it's an unpleasant look.

With this in mind, we find it worrying that Danhua Chemical TechnologyLtd's P/S exceeds that of its industry peers. 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.

What We Can Learn From Danhua Chemical TechnologyLtd's P/S?

Danhua Chemical TechnologyLtd shares have taken a big step in a northerly direction, but its P/S is elevated as a result. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our examination of Danhua Chemical TechnologyLtd revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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.

It is also worth noting that we have found 2 warning signs for Danhua Chemical TechnologyLtd that you need to take into consideration.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.