Unfortunately for some shareholders, the Zhejiang Heda Technology Co., Ltd. (SHSE:688296) share price has dived 30% in the last thirty days, prolonging recent pain. For any long-term shareholders, the last month ends a year to forget by locking in a 57% share price decline.

Following the heavy fall in price, Zhejiang Heda Technology may be sending bullish signals at the moment with its price-to-sales (or "P/S") ratio of 2.5x, since almost half of all companies in the Software industry in China have P/S ratios greater than 4.5x and even P/S higher than 8x are not unusual. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's limited.

How Has Zhejiang Heda Technology Performed Recently?

For example, consider that Zhejiang Heda Technology's financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is low because investors think the company won't do enough to avoid underperforming the broader industry in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Do Revenue Forecasts Match The Low P/S Ratio?

Zhejiang Heda Technology's P/S ratio would be typical for a company that's only expected to deliver limited growth, and importantly, perform worse than the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 27%. This means it has also seen a slide in revenue over the longer-term as revenue is down 5.6% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 28% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's understandable that Zhejiang Heda Technology's P/S would sit below the majority of other companies. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

The Key Takeaway

Zhejiang Heda Technology's recently weak share price has pulled its P/S back below other Software companies. 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.

As we suspected, our examination of Zhejiang Heda Technology revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Given the current circumstances, it seems unlikely that the share price will experience any significant movement in either direction in the near future if recent medium-term revenue trends persist.

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

If you're unsure about the strength of Zhejiang Heda Technology's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.