The Langfang Development Co., Ltd. (SHSE:600149) share price has done very well over the last month, posting an excellent gain of 25%. Notwithstanding the latest gain, the annual share price return of 5.7% isn't as impressive.
Following the firm bounce in price, you could be forgiven for thinking Langfang Development is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 12.3x, considering almost half the companies in China's Trade Distributors industry have P/S ratios below 0.7x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.
View our latest analysis for Langfang Development
How Has Langfang Development Performed Recently?
As an illustration, revenue has deteriorated at Langfang Development over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.
What Are Revenue Growth Metrics Telling Us About The High P/S?
There's an inherent assumption that a company should far outperform the industry for P/S ratios like Langfang Development's to be considered reasonable.
In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 11%. That put a dampener on the good run it was having over the longer-term as its three-year revenue growth is still a noteworthy 13% in total. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable for the company.
This is in contrast to the rest of the industry, which is expected to grow by 18% over the next year, materially higher than the company's recent medium-term annualised growth rates.
In light of this, it's alarming that Langfang Development's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 Langfang Development's P/S?
The strong share price surge has lead to Langfang Development's P/S soaring as well. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.
Our examination of Langfang Development 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 observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. 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 1 warning sign for Langfang Development you should be aware of.
Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.
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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.
