To the annoyance of some shareholders, Shanghai Hongda New Material Co., Ltd. (SZSE:002211) shares are down a considerable 25% in the last month, which continues a horrid run for the company. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 34% in that time.

Even after such a large drop in price, when almost half of the companies in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2x, you may still consider Shanghai Hongda New Material as a stock not worth researching with its 4.1x 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 Shanghai Hongda New Material's Recent Performance Look Like?

For example, consider that Shanghai Hongda New Material's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Shanghai Hongda New Material's Revenue Growth Trending?

In order to justify its P/S ratio, Shanghai Hongda New Material would need to produce outstanding growth that's well in excess of 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 41%. As a result, revenue from three years ago have also fallen 76% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Comparing that to the industry, which is predicted to deliver 23% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Shanghai Hongda New Material's P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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.

What We Can Learn From Shanghai Hongda New Material's P/S?

A significant share price dive has done very little to deflate Shanghai Hongda New Material's very lofty P/S. 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 Hongda New Material 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. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Shanghai Hongda New Material (of which 1 is a bit unpleasant!) you should know about.

If you're unsure about the strength of Shanghai Hongda New Material'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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com