The Zhonghua Gas Holdings Limited (HKG:8246) share price has fared very poorly over the last month, falling by a substantial 28%. The recent drop completes a disastrous twelve months for shareholders, who are sitting on a 53% loss during that time.

Even after such a large drop in price, when almost half of the companies in Hong Kong's Construction industry have price-to-sales ratios (or "P/S") below 0.3x, you may still consider Zhonghua Gas Holdings as a stock probably not worth researching with its 1.4x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Zhonghua Gas Holdings

What Does Zhonghua Gas Holdings' Recent Performance Look Like?

For example, consider that Zhonghua Gas Holdings' financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Zhonghua Gas Holdings' 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 33%. That put a dampener on the good run it was having over the longer-term as its three-year revenue growth is still a noteworthy 5.8% in total. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 14% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that Zhonghua Gas Holdings' P/S exceeds that of its industry peers. 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

Despite the recent share price weakness, Zhonghua Gas Holdings' P/S remains higher than most other companies in the industry. 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 Zhonghua Gas Holdings 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. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

You should always think about risks. Case in point, we've spotted 2 warning signs for Zhonghua Gas Holdings you should be aware of.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.