Shenzhen Original Advanced Compounds Co., Ltd. (SHSE:603991) shares have continued their recent momentum with a 26% gain in the last month alone. Unfortunately, despite the strong performance over the last month, the full year gain of 3.1% isn't as attractive.
Following the firm bounce in price, you could be forgiven for thinking Shenzhen Original Advanced Compounds is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 11.4x, considering almost half the companies in China's Chemicals industry have P/S ratios below 1.8x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.
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How Has Shenzhen Original Advanced Compounds Performed Recently?
Shenzhen Original Advanced Compounds certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. It seems that many are expecting the strong revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.
We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Shenzhen Original Advanced Compounds' earnings, revenue and cash flow.What Are Revenue Growth Metrics Telling Us About The High P/S?
In order to justify its P/S ratio, Shenzhen Original Advanced Compounds would need to produce outstanding growth that's well in excess of the industry.
Taking a look back first, we see that the company grew revenue by an impressive 83% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 9.1% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.
Comparing that to the industry, which is predicted to deliver 24% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.
With this information, we find it concerning that Shenzhen Original Advanced Compounds is trading at a P/S higher than the industry. 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
Shenzhen Original Advanced Compounds' P/S has grown nicely over the last month thanks to a handy boost in the share price. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.
Our examination of Shenzhen Original Advanced Compounds 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. 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.
It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Shenzhen Original Advanced Compounds, and understanding them should be part of your investment process.
If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.
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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.
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