Guangdong Jialong Food Co., Ltd. (SZSE:002495) shareholders won't be pleased to see that the share price has had a very rough month, dropping 41% and undoing the prior period's positive performance. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 33% in that time.

In spite of the heavy fall in price, given around half the companies in China's Food industry have price-to-sales ratios (or "P/S") below 1.6x, you may still consider Guangdong Jialong Food as a stock to avoid entirely with its 7.2x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Has Guangdong Jialong Food Performed Recently?

It looks like revenue growth has deserted Guangdong Jialong Food recently, which is not something to boast about. It might be that many are expecting an improvement to the uninspiring revenue performance over the coming period, which has kept the P/S from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Guangdong Jialong Food's Revenue Growth Trending?

In order to justify its P/S ratio, Guangdong Jialong Food would need to produce outstanding growth that's well in excess of the industry.

If we review the last year of revenue, the company posted a result that saw barely any deviation from a year ago. Fortunately, a few good years before that means that it was still able to grow revenue by 7.0% in total over the last three years. Therefore, it's fair to say that revenue growth has been inconsistent recently for the company.

Comparing that to the industry, which is predicted to deliver 15% 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 Guangdong Jialong Food'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.

The Key Takeaway

Guangdong Jialong Food's shares may have suffered, but its P/S remains high. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

The fact that Guangdong Jialong Food 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. 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. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Guangdong Jialong Food (at least 1 which is potentially serious), and understanding them should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.