Zhejiang Renzhi Co., Ltd. (SZSE:002629) shares have continued their recent momentum with a 56% gain in the last month alone. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 17% over that time.

Following the firm bounce in price, given around half the companies in China's Energy Services industry have price-to-sales ratios (or "P/S") below 2.7x, you may consider Zhejiang Renzhi as a stock to avoid entirely with its 8x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

What Does Zhejiang Renzhi's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Zhejiang Renzhi over the last year, which is not ideal at all. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered a frustrating 5.8% decrease to the company's top line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 26% overall rise in revenue. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of revenue growth.

This is in contrast to the rest of the industry, which is expected to grow by 14% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Zhejiang Renzhi is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

What Does Zhejiang Renzhi's P/S Mean For Investors?

Zhejiang Renzhi's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

The fact that Zhejiang Renzhi currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Zhejiang Renzhi (at least 1 which doesn't sit too well with us), and understanding them should be part of your investment process.

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