Shanghai Dragon Corporation (SHSE:600630) shares have retraced a considerable 29% in the last month, reversing a fair amount of their solid recent performance. Still, a bad month hasn't completely ruined the past year with the stock gaining 72%, which is great even in a bull market.

Even after such a large drop in price, when almost half of the companies in China's Luxury industry have price-to-sales ratios (or "P/S") below 1.4x, you may still consider Shanghai Dragon as a stock probably not worth researching with its 3.1x 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.

How Shanghai Dragon Has Been Performing

For instance, Shanghai Dragon's receding revenue in recent times would have to be some food for thought. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Shanghai Dragon?

In order to justify its P/S ratio, Shanghai Dragon would need to produce impressive growth in excess of the industry.

Retrospectively, the last year delivered a frustrating 48% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 62% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 20% 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 Shanghai Dragon'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. 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.

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

There's still some elevation in Shanghai Dragon's P/S, even if the same can't be said for its share price recently. 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 Shanghai Dragon 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. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shanghai Dragon, and understanding them should be part of your investment process.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.