Zhuhai Zhongfu Enterprise Co.,Ltd (SZSE:000659) shares have continued their recent momentum with a 30% gain in the last month alone. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 20% over that time.

After such a large jump in price, given close to half the companies operating in China's Packaging industry have price-to-sales ratios (or "P/S") below 1.5x, you may consider Zhuhai Zhongfu EnterpriseLtd as a stock to potentially avoid with its 2.9x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Zhuhai Zhongfu EnterpriseLtd Has Been Performing

For example, consider that Zhuhai Zhongfu EnterpriseLtd'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.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as high as Zhuhai Zhongfu EnterpriseLtd's is when the company's growth is on track to outshine the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 20%. The last three years don't look nice either as the company has shrunk revenue by 22% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 17% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Zhuhai Zhongfu EnterpriseLtd'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

Zhuhai Zhongfu EnterpriseLtd's P/S is on the rise since its shares have risen strongly. 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 Zhuhai Zhongfu EnterpriseLtd 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. 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.

Before you take the next step, you should know about the 2 warning signs for Zhuhai Zhongfu EnterpriseLtd (1 doesn't sit too well with us!) that we have uncovered.

If you're unsure about the strength of Zhuhai Zhongfu EnterpriseLtd's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.