Shanghai Shenda Co., Ltd (SHSE:600626) shareholders would be excited to see that the share price has had a great month, posting a 36% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 14% over that time.

Although its price has surged higher, there still wouldn't be many who think Shanghai Shenda's price-to-sales (or "P/S") ratio of 0.4x is worth a mention when the median P/S in China's Retail Distributors industry is similar at about 0.3x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

What Does Shanghai Shenda's P/S Mean For Shareholders?

Shanghai Shenda has been doing a decent job lately as it's been growing revenue at a reasonable pace. It might be that many expect the respectable revenue performance to only match most other companies over the coming period, which has kept the P/S from rising. If not, then at least existing shareholders probably aren't too pessimistic about the future direction of the share price.

Do Revenue Forecasts Match The P/S Ratio?

There's an inherent assumption that a company should be matching the industry for P/S ratios like Shanghai Shenda's to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 4.3%. The solid recent performance means it was also able to grow revenue by 10% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been respectable for the company.

Comparing that to the industry, which is predicted to deliver 31% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

In light of this, it's curious that Shanghai Shenda's P/S sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as a continuation of recent revenue trends is likely to weigh down the shares eventually.

The Key Takeaway

Its shares have lifted substantially and now Shanghai Shenda's P/S is back within range of the industry median. 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.

We've established that Shanghai Shenda's average P/S is a bit surprising since its recent three-year growth is lower than the wider industry forecast. Right now we are uncomfortable with the P/S as this revenue performance isn't likely to support a more positive sentiment for long. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

You should always think about risks. Case in point, we've spotted 2 warning signs for Shanghai Shenda you should be aware of, and 1 of them is potentially serious.

If these risks are making you reconsider your opinion on Shanghai Shenda, explore our interactive list of high quality stocks to get an idea of what else is out there.

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.

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