Shanghai Dazhong Public Utilities(Group) Co.,Ltd. (SHSE:600635) shareholders would be excited to see that the share price has had a great month, posting a 30% gain and recovering from prior weakness. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Following the firm bounce in price, given close to half the companies operating in China's Gas Utilities industry have price-to-sales ratios (or "P/S") below 1x, you may consider Shanghai Dazhong Public Utilities(Group)Ltd as a stock to potentially avoid with its 1.6x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

What Does Shanghai Dazhong Public Utilities(Group)Ltd's P/S Mean For Shareholders?

Revenue has risen at a steady rate over the last year for Shanghai Dazhong Public Utilities(Group)Ltd, which is generally not a bad outcome. Perhaps the market believes the recent revenue performance is strong enough to outperform the industry, which has inflated the P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For Shanghai Dazhong Public Utilities(Group)Ltd?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Shanghai Dazhong Public Utilities(Group)Ltd's to be considered reasonable.

Retrospectively, the last year delivered a decent 6.7% gain to the company's revenues. Revenue has also lifted 21% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have probably been satisfied with the medium-term rates of revenue growth.

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 information, we find it concerning that Shanghai Dazhong Public Utilities(Group)Ltd is trading at a P/S higher than the industry. 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.

What Does Shanghai Dazhong Public Utilities(Group)Ltd's P/S Mean For Investors?

The large bounce in Shanghai Dazhong Public Utilities(Group)Ltd's shares has lifted the company's P/S handsomely. 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 Dazhong Public Utilities(Group)Ltd revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

You should always think about risks. Case in point, we've spotted 3 warning signs for Shanghai Dazhong Public Utilities(Group)Ltd you should be aware of.

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.

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