The China Hongbao Holdings Limited (HKG:8316) share price has fared very poorly over the last month, falling by a substantial 51%. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 36% share price drop.

Although its price has dipped substantially, you could still be forgiven for thinking China Hongbao Holdings is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 2.5x, considering almost half the companies in Hong Kong's Construction industry have P/S ratios below 0.3x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

View our latest analysis for China Hongbao Holdings

What Does China Hongbao Holdings' Recent Performance Look Like?

Recent times have been quite advantageous for China Hongbao Holdings as its revenue has been rising very briskly. It seems that many are expecting the strong revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, China Hongbao Holdings would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered an exceptional 33% gain to the company's top line. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 5.5% overall. 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 13% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that China Hongbao Holdings' 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

Even after such a strong price drop, China Hongbao Holdings' P/S still exceeds the industry median significantly. 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.

We've established that China Hongbao Holdings currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You should always think about risks. Case in point, we've spotted 7 warning signs for China Hongbao Holdings you should be aware of, and 4 of them are a bit unpleasant.

If these risks are making you reconsider your opinion on China Hongbao Holdings, 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.