China Sanjiang Fine Chemicals Company Limited (HKG:2198) shares have had a really impressive month, gaining 35% after a shaky period beforehand. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 9.3% over the last year.

Even after such a large jump in price, it's still not a stretch to say that China Sanjiang Fine Chemicals' price-to-sales (or "P/S") ratio of 0.2x right now seems quite "middle-of-the-road" compared to the Chemicals industry in Hong Kong, where the median P/S ratio is around 0.3x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

How Has China Sanjiang Fine Chemicals Performed Recently?

For example, consider that China Sanjiang Fine Chemicals' financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is moderate because investors think the company might still do enough to be in line with the broader industry in the near future. If you like the company, you'd at least be hoping this is the case so that you could potentially pick up some stock while it's not quite in favour.

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

There's an inherent assumption that a company should be matching the industry for P/S ratios like China Sanjiang Fine Chemicals' to be considered reasonable.

Retrospectively, the last year delivered a frustrating 11% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 2.7% in total over the last three years. 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 4.5% 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 China Sanjiang Fine Chemicals is trading at a fairly similar P/S compared to 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh on the share price eventually.

The Key Takeaway

Its shares have lifted substantially and now China Sanjiang Fine Chemicals' P/S is back within range of the industry median. 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.

The fact that China Sanjiang Fine Chemicals currently trades at a P/S on par with the rest of the industry is surprising to us since its recent revenues have been in decline over the medium-term, all while the industry is set to grow. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Before you take the next step, you should know about the 2 warning signs for China Sanjiang Fine Chemicals that we have uncovered.

If you're unsure about the strength of China Sanjiang Fine Chemicals' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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