Those holding Shanghai Dragon Corporation (SHSE:600630) shares would be relieved that the share price has rebounded 27% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Looking back a bit further, it's encouraging to see the stock is up 86% in the last year.

Since its price has surged higher, when almost half of the companies in China's Luxury industry have price-to-sales ratios (or "P/S") below 1.6x, you may consider Shanghai Dragon as a stock probably not worth researching with its 2.4x 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 as high as it is.

How Shanghai Dragon Has Been Performing

For instance, Shanghai Dragon's receding revenue in recent times would have to be some food for thought. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 12% decrease to the company's top line. As a result, revenue from three years ago have also fallen 45% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 17% 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 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. 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 Bottom Line On Shanghai Dragon's P/S

Shanghai Dragon's P/S is on the rise since its shares have risen strongly. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

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. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Having said that, be aware Shanghai Dragon is showing 2 warning signs in our investment analysis, you should know about.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.