Shenzhen Water Planning & Design Institute Co., Ltd. (SZSE:301038) shares have had a really impressive month, gaining 26% after a shaky period beforehand. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 6.7% over the last year.

Since its price has surged higher, you could be forgiven for thinking Shenzhen Water Planning & Design Institute is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.4x, considering almost half the companies in China's Commercial Services industry have P/S ratios below 2.5x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Has Shenzhen Water Planning & Design Institute Performed Recently?

The recent revenue growth at Shenzhen Water Planning & Design Institute would have to be considered satisfactory if not spectacular. One possibility is that the P/S ratio is high because investors think this good revenue growth will be enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Shenzhen Water Planning & Design Institute's Revenue Growth Trending?

In order to justify its P/S ratio, Shenzhen Water Planning & Design Institute would need to produce impressive growth in excess of the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 4.4% last year. Still, lamentably revenue has fallen 9.8% in aggregate from three years ago, which is disappointing. 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 28% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Shenzhen Water Planning & Design Institute is trading at a P/S higher than the industry. 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 Key Takeaway

The large bounce in Shenzhen Water Planning & Design Institute'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 Shenzhen Water Planning & Design Institute 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. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shenzhen Water Planning & Design Institute (at least 1 which shouldn't be ignored), and understanding these should be part of your investment process.

If you're unsure about the strength of Shenzhen Water Planning & Design Institute's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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