There wouldn't be many who think Nine Dragons Paper (Holdings) Limited's (HKG:2689) price-to-sales (or "P/S") ratio of 0.2x is worth a mention when the median P/S for the Forestry industry in Hong Kong is similar at about 0.7x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

What Does Nine Dragons Paper (Holdings)'s P/S Mean For Shareholders?

Nine Dragons Paper (Holdings) certainly has been doing a good job lately as its revenue growth has been positive while most other companies have been seeing their revenue go backwards. It might be that many expect the strong revenue performance to deteriorate like the rest, which has kept the P/S ratio from rising. If not, then existing shareholders have reason to be feeling optimistic about the future direction of the share price.

What Are Revenue Growth Metrics Telling Us About The P/S?

There's an inherent assumption that a company should be matching the industry for P/S ratios like Nine Dragons Paper (Holdings)'s to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 4.9%. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 3.4% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Turning to the outlook, the next three years should generate growth of 4.5% per annum as estimated by the nine analysts watching the company. With the industry predicted to deliver 8.6% growth each year, the company is positioned for a weaker revenue result.

In light of this, it's curious that Nine Dragons Paper (Holdings)'s P/S sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

What We Can Learn From Nine Dragons Paper (Holdings)'s P/S?

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Given that Nine Dragons Paper (Holdings)'s revenue growth projections are relatively subdued in comparison to the wider industry, it comes as a surprise to see it trading at its current P/S ratio. When we see companies with a relatively weaker revenue outlook compared to the industry, we suspect the share price is at risk of declining, sending the moderate P/S lower. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 1 warning sign for Nine Dragons Paper (Holdings) that you need to take into consideration.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.