Shanghai HYP-ARCH Architectural Design Consultant Co.,Ltd. (SZSE:301024) shareholders are no doubt pleased to see that the share price has bounced 36% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 15% over that time.

Since its price has surged higher, given around half the companies in China's Professional Services industry have price-to-sales ratios (or "P/S") below 3x, you may consider Shanghai HYP-ARCH Architectural Design ConsultantLtd as a stock to avoid entirely with its 7.9x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

What Does Shanghai HYP-ARCH Architectural Design ConsultantLtd's P/S Mean For Shareholders?

For example, consider that Shanghai HYP-ARCH Architectural Design ConsultantLtd's financial performance has been poor lately as its revenue has been in decline. 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.

How Is Shanghai HYP-ARCH Architectural Design ConsultantLtd's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as steep as Shanghai HYP-ARCH Architectural Design ConsultantLtd's 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 16%. This means it has also seen a slide in revenue over the longer-term as revenue is down 46% in total over the last three years. 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 95% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Shanghai HYP-ARCH Architectural Design ConsultantLtd'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. 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 Key Takeaway

The strong share price surge has lead to Shanghai HYP-ARCH Architectural Design ConsultantLtd's P/S soaring as well. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Shanghai HYP-ARCH Architectural Design ConsultantLtd 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

It is also worth noting that we have found 2 warning signs for Shanghai HYP-ARCH Architectural Design ConsultantLtd that you need to take into consideration.

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.