Hengxin Shambala Culture Co.,Ltd. (SZSE:300081) shareholders have had their patience rewarded with a 43% share price jump in the last month. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 22% in the last twelve months.

Since its price has surged higher, you could be forgiven for thinking Hengxin Shambala CultureLtd is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 10.2x, considering almost half the companies in China's Software industry have P/S ratios below 5.2x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Hengxin Shambala CultureLtd Has Been Performing

As an illustration, revenue has deteriorated at Hengxin Shambala CultureLtd over the last year, which is not ideal at all. 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 Hengxin Shambala CultureLtd's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as steep as Hengxin Shambala CultureLtd's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered a frustrating 26% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 1.7% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 26% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Hengxin Shambala CultureLtd'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.

The Final Word

Hengxin Shambala CultureLtd's P/S has grown nicely over the last month thanks to a handy boost in the share price. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Hengxin Shambala CultureLtd 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. 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. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Hengxin Shambala CultureLtd, and understanding these should be part of your investment process.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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