Despite an already strong run, Dalian Friendship (Group) Co., Ltd. (SZSE:000679) shares have been powering on, with a gain of 26% in the last thirty days. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 42% over that time.

Since its price has surged higher, when almost half of the companies in China's Multiline Retail industry have price-to-sales ratios (or "P/S") below 1.4x, you may consider Dalian Friendship (Group) as a stock not worth researching with its 7.8x 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.

How Dalian Friendship (Group) Has Been Performing

Dalian Friendship (Group) has been doing a decent job lately as it's been growing revenue at a reasonable pace. Perhaps the market believes the recent revenue performance is strong enough to outperform the industry, which has inflated the P/S ratio. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

Dalian Friendship (Group)'s P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 4.2%. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 19% 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.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 15% shows it's an unpleasant look.

In light of this, it's alarming that Dalian Friendship (Group)'s P/S sits above the majority of other companies. 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.

The Final Word

The strong share price surge has lead to Dalian Friendship (Group)'s P/S soaring as well. 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.

We've established that Dalian Friendship (Group) currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Dalian Friendship (Group) you should know about.

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.