Jiangxi Hungpai New Material Co., Ltd. (SHSE:605366) shares have had a really impressive month, gaining 41% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 12% in the last twelve months.

After such a large jump in price, given close to half the companies operating in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2.1x, you may consider Jiangxi Hungpai New Material as a stock to potentially avoid with its 2.9x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does Jiangxi Hungpai New Material's P/S Mean For Shareholders?

The recent revenue growth at Jiangxi Hungpai New Material would have to be considered satisfactory if not spectacular. 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 outperform the industry for P/S ratios like Jiangxi Hungpai New Material's to be considered reasonable.

Taking a look back first, we see that the company managed to grow revenues by a handy 3.5% last year. The latest three year period has also seen an excellent 47% overall rise in revenue, aided somewhat by its short-term performance. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 21% shows it's noticeably less attractive.

With this in mind, we find it worrying that Jiangxi Hungpai New Material's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Bottom Line On Jiangxi Hungpai New Material's P/S

The large bounce in Jiangxi Hungpai New Material's shares has lifted the company's P/S handsomely. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Jiangxi Hungpai New Material 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. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely 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.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Jiangxi Hungpai New Material (1 shouldn't be ignored!) that you should be aware of before investing here.

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.