Guangdong Fangyuan New Materials Group Co., Ltd. (SHSE:688148) shareholders won't be pleased to see that the share price has had a very rough month, dropping 25% and undoing the prior period's positive performance. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 36% share price drop.

Since its price has dipped substantially, it would be understandable if you think Guangdong Fangyuan New Materials Group is a stock with good investment prospects with a price-to-sales ratios (or "P/S") of 1.4x, considering almost half the companies in China's Chemicals industry have P/S ratios above 2.2x. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

What Does Guangdong Fangyuan New Materials Group's P/S Mean For Shareholders?

For instance, Guangdong Fangyuan New Materials Group's receding revenue in recent times would have to be some food for thought. One possibility is that the P/S is low because investors think the company won't do enough to avoid underperforming the broader industry in the near future. Those who are bullish on Guangdong Fangyuan New Materials Group 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 Guangdong Fangyuan New Materials Group?

There's an inherent assumption that a company should underperform the industry for P/S ratios like Guangdong Fangyuan New Materials Group's to be considered reasonable.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 45%. As a result, revenue from three years ago have also fallen 17% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

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 are not surprised that Guangdong Fangyuan New Materials Group is trading at a P/S lower than the industry. 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. Even just maintaining these prices could be difficult to achieve as recent revenue trends are already weighing down the shares.

The Final Word

Guangdong Fangyuan New Materials Group's recently weak share price has pulled its P/S back below other Chemicals companies. 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 Guangdong Fangyuan New Materials Group 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. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Guangdong Fangyuan New Materials Group (at least 1 which is concerning), and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Guangdong Fangyuan New Materials 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.