Shanghai HYP-ARCH Architectural Design Consultant Co.,Ltd. (SZSE:301024) shareholders that were waiting for something to happen have been dealt a blow with a 25% share price drop in the last month. Longer-term shareholders would now have taken a real hit with the stock declining 3.5% in the last year.

Even after such a large drop in price, when almost half of the companies in China's Professional Services industry have price-to-sales ratios (or "P/S") below 2.8x, you may still consider Shanghai HYP-ARCH Architectural Design ConsultantLtd as a stock not worth researching with its 8.5x P/S ratio. 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.

What Does Shanghai HYP-ARCH Architectural Design ConsultantLtd's Recent Performance Look Like?

For example, consider that Shanghai HYP-ARCH Architectural Design ConsultantLtd'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Revenue Growth Metrics Telling Us About The High P/S?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shanghai HYP-ARCH Architectural Design ConsultantLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 16% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 46% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 22% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Shanghai HYP-ARCH Architectural Design ConsultantLtd is trading at a P/S higher than the industry. 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.

What Does Shanghai HYP-ARCH Architectural Design ConsultantLtd's P/S Mean For Investors?

Even after such a strong price drop, Shanghai HYP-ARCH Architectural Design ConsultantLtd's P/S still exceeds the industry median significantly. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Shanghai HYP-ARCH Architectural Design ConsultantLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Shanghai HYP-ARCH Architectural Design ConsultantLtd 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.