You may think that with a price-to-sales (or "P/S") ratio of 6.2x HCR Co., Ltd (SHSE:688500) is a stock to avoid completely, seeing as almost half of all the Professional Services companies in China have P/S ratios under 3.9x and even P/S lower than 1.8x aren't out of the ordinary. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does HCR's P/S Mean For Shareholders?

For example, consider that HCR's financial performance has been poor lately as its revenue has been in decline. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

How Is HCR's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like HCR'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 5.8%. The last three years don't look nice either as the company has shrunk revenue by 3.9% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 28% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that HCR'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. 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 HCR'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.

Our examination of HCR 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. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. 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.

You should always think about risks. Case in point, we've spotted 1 warning sign for HCR you should be aware of.

If you're unsure about the strength of HCR's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.