Zhejiang Heda Technology Co., Ltd. (SHSE:688296) shareholders would be excited to see that the share price has had a great month, posting a 50% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 23% over that time.

Even after such a large jump in price, Zhejiang Heda Technology's price-to-sales (or "P/S") ratio of 3.3x might still make it look like a buy right now compared to the Software industry in China, where around half of the companies have P/S ratios above 5.8x and even P/S above 11x are quite common. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's limited.

How Zhejiang Heda Technology Has Been Performing

For example, consider that Zhejiang Heda Technology's financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the recent revenue performance isn't good enough to keep up the industry, causing the P/S ratio to suffer. Those who are bullish on Zhejiang Heda Technology will be hoping that this isn't the case so that they can pick up the stock at a lower valuation.

Is There Any Revenue Growth Forecasted For Zhejiang Heda Technology?

The only time you'd be truly comfortable seeing a P/S as low as Zhejiang Heda Technology's is when the company's growth is on track to lag the industry.

Retrospectively, the last year delivered a frustrating 3.2% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 8.1% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 26% shows it's an unpleasant look.

With this in mind, we understand why Zhejiang Heda Technology's P/S is lower than most of its industry peers. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

The Final Word

The latest share price surge wasn't enough to lift Zhejiang Heda Technology's P/S close to the industry median. 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.

As we suspected, our examination of Zhejiang Heda Technology revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. If recent medium-term revenue trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

Plus, you should also learn about this 1 warning sign we've spotted with Zhejiang Heda Technology.

If these risks are making you reconsider your opinion on Zhejiang Heda 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.