Zhejiang Renzhi Co., Ltd. (SZSE:002629) shares have continued their recent momentum with a 31% gain in the last month alone. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 44% over that time.

After such a large jump in price, given around half the companies in China's Energy Services industry have price-to-sales ratios (or "P/S") below 2.1x, you may consider Zhejiang Renzhi as a stock to avoid entirely with its 4.8x 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 Zhejiang Renzhi's P/S Mean For Shareholders?

Zhejiang Renzhi 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Zhejiang Renzhi's to be considered reasonable.

Taking a look back first, we see that the company managed to grow revenues by a handy 3.3% last year. This was backed up an excellent period prior to see revenue up by 50% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Comparing that to the industry, which is predicted to deliver 21% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this information, we find it concerning that Zhejiang Renzhi is trading at a P/S higher than the industry. 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Bottom Line On Zhejiang Renzhi's P/S

Zhejiang Renzhi's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

Our examination of Zhejiang Renzhi 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 there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

Before you settle on your opinion, we've discovered 3 warning signs for Zhejiang Renzhi (1 is significant!) that you should be aware of.

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.