When close to half the companies in the Software industry in China have price-to-sales ratios (or "P/S") below 6.8x, you may consider Shanghai Information2 Software Inc. (SHSE:688435) as a stock to avoid entirely with its 25.9x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

See our latest analysis for Shanghai Information2 Software

How Shanghai Information2 Software Has Been Performing

With revenue growth that's exceedingly strong of late, Shanghai Information2 Software has been doing very well. Perhaps the market is expecting future revenue performance to outperform the wider market, which has seemingly got people interested in the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Shanghai Information2 Software's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as steep as Shanghai Information2 Software's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered an exceptional 34% gain to the company's top line. The strong recent performance means it was also able to grow revenue by 67% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 37% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that Shanghai Information2 Software's P/S exceeds that of its industry peers. 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 good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What We Can Learn From Shanghai Information2 Software's P/S?

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Shanghai Information2 Software revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. 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 2 warning signs with Shanghai Information2 Software, and understanding these should be part of your investment process.

If you're unsure about the strength of Shanghai Information2 Software's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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.