Shouhang High-Tech Energy Co., Ltd. (SZSE:002665) shares have had a horrible month, losing 34% after a relatively good period beforehand. The recent drop completes a disastrous twelve months for shareholders, who are sitting on a 63% loss during that time.

In spite of the heavy fall in price, when almost half of the companies in China's Building industry have price-to-sales ratios (or "P/S") below 1.8x, you may still consider Shouhang High-Tech Energy as a stock probably not worth researching with its 3.3x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

What Does Shouhang High-Tech Energy's P/S Mean For Shareholders?

With revenue growth that's exceedingly strong of late, Shouhang High-Tech Energy has been doing very well. The P/S ratio is probably high because investors think this strong revenue growth will be enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

There's an inherent assumption that a company should outperform the industry for P/S ratios like Shouhang High-Tech Energy's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 48% last year. The strong recent performance means it was also able to grow revenue by 35% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 18% shows it's noticeably less attractive.

In light of this, it's alarming that Shouhang High-Tech Energy's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Final Word

There's still some elevation in Shouhang High-Tech Energy's P/S, even if the same can't be said for its share price recently. 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 Shouhang High-Tech Energy currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. 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.

The company's balance sheet is another key area for risk analysis. You can assess many of the main risks through our free balance sheet analysis for Shouhang High-Tech Energy with six simple checks.

If you're unsure about the strength of Shouhang High-Tech Energy's 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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