Hubei Guochuang Hi-tech Material Co.,Ltd (SZSE:002377) shares have continued their recent momentum with a 29% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 34%.

Since its price has surged higher, given around half the companies in China's Real Estate industry have price-to-sales ratios (or "P/S") below 2.6x, you may consider Hubei Guochuang Hi-tech MaterialLtd as a stock to avoid entirely with its 6.3x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Hubei Guochuang Hi-tech MaterialLtd's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Hubei Guochuang Hi-tech MaterialLtd over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Hubei Guochuang Hi-tech MaterialLtd?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Hubei Guochuang Hi-tech MaterialLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 58% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 88% 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 11% 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 Hubei Guochuang Hi-tech MaterialLtd's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Key Takeaway

Hubei Guochuang Hi-tech MaterialLtd's P/S has grown nicely over the last month thanks to a handy boost in the share price. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Hubei Guochuang Hi-tech MaterialLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You should always think about risks. Case in point, we've spotted 1 warning sign for Hubei Guochuang Hi-tech MaterialLtd you should be aware of.

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.