Unfortunately for some shareholders, the Shenzhen Universe Group Co., Ltd. (SZSE:000023) share price has dived 39% in the last thirty days, prolonging recent pain. The recent drop completes a disastrous twelve months for shareholders, who are sitting on a 70% loss during that time.

Even after such a large drop in price, given close to half the companies operating in China's Basic Materials industry have price-to-sales ratios (or "P/S") below 1.2x, you may still consider Shenzhen Universe Group as a stock to potentially avoid with its 1.7x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

What Does Shenzhen Universe Group's P/S Mean For Shareholders?

For example, consider that Shenzhen Universe Group'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.

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

Shenzhen Universe Group's P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 68%. The last three years don't look nice either as the company has shrunk revenue by 87% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 5.1% shows it's an unpleasant look.

In light of this, it's alarming that Shenzhen Universe Group'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. 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.

The Final Word

There's still some elevation in Shenzhen Universe Group's P/S, even if the same can't be said for its share price recently. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Our examination of Shenzhen Universe Group 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. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Shenzhen Universe Group (1 can't be ignored) you should be aware of.

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.