Shanghai DragonNet Technology Co.,Ltd. (SZSE:300245) shares have continued their recent momentum with a 30% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 59% in the last year.

After such a large jump in price, Shanghai DragonNet TechnologyLtd may be sending strong sell signals at present with a price-to-sales (or "P/S") ratio of 10.9x, when you consider almost half of the companies in the IT industry in China have P/S ratios under 5.1x and even P/S lower than 2x aren't out of the ordinary. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

How Has Shanghai DragonNet TechnologyLtd Performed Recently?

As an illustration, revenue has deteriorated at Shanghai DragonNet TechnologyLtd over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Shanghai DragonNet TechnologyLtd?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shanghai DragonNet TechnologyLtd's to be considered reasonable.

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 26%. The last three years don't look nice either as the company has shrunk revenue by 21% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 19% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Shanghai DragonNet TechnologyLtd's 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Bottom Line On Shanghai DragonNet TechnologyLtd's P/S

The strong share price surge has lead to Shanghai DragonNet TechnologyLtd's P/S soaring as well. 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 Shanghai DragonNet 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. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. 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's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shanghai DragonNet TechnologyLtd, and understanding them should be part of your investment process.

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.