Hengxin Shambala Culture Co.,Ltd. (SZSE:300081) shareholders won't be pleased to see that the share price has had a very rough month, dropping 33% 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 14% share price drop.

In spite of the heavy fall in price, Hengxin Shambala CultureLtd's price-to-sales (or "P/S") ratio of 6.8x might still make it look like a strong sell right now compared to other companies in the Software industry in China, where around half of the companies have P/S ratios below 4.3x and even P/S below 2x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Hengxin Shambala CultureLtd's Recent Performance Look Like?

With revenue growth that's exceedingly strong of late, Hengxin Shambala CultureLtd has been doing very well. Perhaps the market is expecting future revenue performance to outperform the wider market, which has seemingly got people interested in the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Revenue Growth Metrics Telling Us About The High P/S?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Hengxin Shambala CultureLtd's to be considered reasonable.

If we review the last year of revenue growth, the company posted a terrific increase of 97%. Pleasingly, revenue has also lifted 36% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been superb for the company.

This is in contrast to the rest of the industry, which is expected to grow by 34% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Hengxin Shambala CultureLtd's P/S sits above the majority of other companies. 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

A significant share price dive has done very little to deflate Hengxin Shambala CultureLtd's very lofty P/S. 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.

Our examination of Hengxin Shambala CultureLtd 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. 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.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Hengxin Shambala CultureLtd that you should be aware of.

If these risks are making you reconsider your opinion on Hengxin Shambala CultureLtd, 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.