Hangzhou Wensli Silk Culture Co., Ltd. (SZSE:301066) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 30% in that time.

In spite of the heavy fall in price, given close to half the companies operating in China's Luxury industry have price-to-sales ratios (or "P/S") below 1.6x, you may still consider Hangzhou Wensli Silk Culture as a stock to potentially avoid with its 2.8x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does Hangzhou Wensli Silk Culture's P/S Mean For Shareholders?

Hangzhou Wensli Silk Culture has been doing a good job lately as it's been growing revenue at a solid pace. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Hangzhou Wensli Silk Culture?

Hangzhou Wensli Silk Culture's P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

Retrospectively, the last year delivered a decent 11% gain to the company's revenues. However, this wasn't enough as the latest three year period has seen an unpleasant 14% overall drop in revenue. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 20% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Hangzhou Wensli Silk Culture is trading at a P/S higher than the industry. 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 Bottom Line On Hangzhou Wensli Silk Culture's P/S

Hangzhou Wensli Silk Culture's P/S remain high even after its stock plunged. 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 Hangzhou Wensli Silk Culture 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. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. 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.

Having said that, be aware Hangzhou Wensli Silk Culture is showing 3 warning signs in our investment analysis, and 1 of those is a bit unpleasant.

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

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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.