The Sichuan Xunyou Network Technology Co., Ltd. (SZSE:300467) share price has done very well over the last month, posting an excellent gain of 29%. Looking further back, the 11% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Since its price has surged higher, Sichuan Xunyou Network Technology may be sending strong sell signals at present with a price-to-sales (or "P/S") ratio of 10x, when you consider almost half of the companies in the Entertainment industry in China have P/S ratios under 6.3x and even P/S lower than 3x aren't out of the ordinary. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Sichuan Xunyou Network Technology Has Been Performing

For example, consider that Sichuan Xunyou Network Technology's financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Sichuan Xunyou Network Technology's Revenue Growth Trending?

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

Retrospectively, the last year delivered a frustrating 13% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 31% in total over the last three years. 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 in mind, we find it worrying that Sichuan Xunyou Network Technology'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. 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 Final Word

The strong share price surge has lead to Sichuan Xunyou Network Technology'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.

Our examination of Sichuan Xunyou Network Technology 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. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Sichuan Xunyou Network Technology with six simple checks.

If these risks are making you reconsider your opinion on Sichuan Xunyou Network Technology, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.