Shanghai Yanhua Smartech Group Co., Ltd. (SZSE:002178) shares have retraced a considerable 29% in the last month, reversing a fair amount of their solid recent performance. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 11% in that time.

In spite of the heavy fall in price, when almost half of the companies in China's Construction industry have price-to-sales ratios (or "P/S") below 1.3x, you may still consider Shanghai Yanhua Smartech Group as a stock not worth researching with its 6.4x 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.

How Has Shanghai Yanhua Smartech Group Performed Recently?

As an illustration, revenue has deteriorated at Shanghai Yanhua Smartech Group over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Shanghai Yanhua Smartech Group?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shanghai Yanhua Smartech Group's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 13% decrease to the company's top line. As a result, revenue from three years ago have also fallen 22% overall. 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 12% 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 Shanghai Yanhua Smartech Group's P/S exceeds that of its industry peers. 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 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.

The Key Takeaway

Even after such a strong price drop, Shanghai Yanhua Smartech Group's P/S still exceeds the industry median significantly. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've established that Shanghai Yanhua Smartech 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. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shanghai Yanhua Smartech Group (at least 1 which is significant), and understanding them should be part of your investment process.

If these risks are making you reconsider your opinion on Shanghai Yanhua Smartech Group, 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.