To the annoyance of some shareholders, Hongbo Co.,Ltd. (SZSE:002229) shares are down a considerable 29% in the last month, which continues a horrid run for the company. Of course, over the longer-term many would still wish they owned shares as the stock's price has soared 133% in the last twelve months.

Even after such a large drop in price, when almost half of the companies in China's Commercial Services industry have price-to-sales ratios (or "P/S") below 2.7x, you may still consider HongboLtd as a stock not worth researching with its 14.9x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does HongboLtd's P/S Mean For Shareholders?

HongboLtd has been doing a good job lately as it's been growing revenue at a solid pace. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For HongboLtd?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like HongboLtd's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 19% last year. The latest three year period has also seen a 13% overall rise in revenue, aided extensively by its short-term performance. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

This is in contrast to the rest of the industry, which is expected to grow by 30% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this in mind, we find it worrying that HongboLtd's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Final Word

A significant share price dive has done very little to deflate HongboLtd's very lofty P/S. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

The fact that HongboLtd currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely to support such 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.

Before you take the next step, you should know about the 2 warning signs for HongboLtd (1 is potentially serious!) that we have uncovered.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.