SEP Analytical (Shanghai) Co., Ltd. (SZSE:301228) shareholders are no doubt pleased to see that the share price has bounced 41% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 16% over that time.

Since its price has surged higher, when almost half of the companies in China's Professional Services industry have price-to-sales ratios (or "P/S") below 2.5x, you may consider SEP Analytical (Shanghai) as a stock probably not worth researching with its 4.1x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

How Has SEP Analytical (Shanghai) Performed Recently?

The recent revenue growth at SEP Analytical (Shanghai) would have to be considered satisfactory if not spectacular. One possibility is that the P/S ratio is high because investors think this good revenue growth will be 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 SEP Analytical (Shanghai)?

The only time you'd be truly comfortable seeing a P/S as high as SEP Analytical (Shanghai)'s is when the company's growth is on track to outshine the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 3.4% last year. Still, revenue has barely risen at all in aggregate from three years ago, which is not ideal. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

This is in contrast to the rest of the industry, which is expected to grow by 44% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that SEP Analytical (Shanghai) is trading at a P/S higher than the industry. It seems most investors are ignoring the fairly limited recent growth rates 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 Final Word

The large bounce in SEP Analytical (Shanghai)'s shares has lifted the company's P/S handsomely. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

The fact that SEP Analytical (Shanghai) currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely to support such positive sentiment for long. 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.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for SEP Analytical (Shanghai) 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).

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com