Dawei Technology (Guangdong) Group Co., Ltd. (SHSE:600589) shares have continued their recent momentum with a 30% gain in the last month alone. Looking further back, the 17% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

After such a large jump in price, given around half the companies in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2.5x, you may consider Dawei Technology (Guangdong) Group as a stock to avoid entirely with its 20.5x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Dawei Technology (Guangdong) Group's Recent Performance Look Like?

It looks like revenue growth has deserted Dawei Technology (Guangdong) Group recently, which is not something to boast about. One possibility is that the P/S is high because investors think the benign revenue growth will improve to outperform the broader industry in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Dawei Technology (Guangdong) Group?

In order to justify its P/S ratio, Dawei Technology (Guangdong) Group would need to produce outstanding growth that's well in excess of the industry.

Taking a look back first, we see that there was hardly any revenue growth to speak of for the company over the past year. Whilst it's an improvement, it wasn't enough to get the company out of the hole it was in, with revenue down 65% overall from three years ago. 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 25% 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 Dawei Technology (Guangdong) Group 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.

What We Can Learn From Dawei Technology (Guangdong) Group's P/S?

Dawei Technology (Guangdong) Group's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

We've established that Dawei Technology (Guangdong) Group currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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.

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

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.