Zhonghua Gas Holdings Limited (HKG:8246) shares have had a really impressive month, gaining 33% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 12% in the last twelve months.

Since its price has surged higher, given around half the companies in Hong Kong's Construction industry have price-to-sales ratios (or "P/S") below 0.3x, you may consider Zhonghua Gas Holdings as a stock to avoid entirely with its 2.6x 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.

What Does Zhonghua Gas Holdings' P/S Mean For Shareholders?

For instance, Zhonghua Gas Holdings' receding revenue in recent times would have to be some food for thought. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as Zhonghua Gas Holdings' is when the company's growth is on track to outshine the industry decidedly.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 12%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 7.6% overall rise in revenue. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable for the company.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 13% shows it's noticeably less attractive.

With this in mind, we find it worrying that Zhonghua Gas Holdings' 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. 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 Final Word

Shares in Zhonghua Gas Holdings have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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 Zhonghua Gas Holdings 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. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Zhonghua Gas Holdings, and understanding 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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