When close to half the companies in the Capital Markets industry in China have price-to-sales ratios (or "P/S") below 6.3x, you may consider Shanghai DZH Limited (SHSE:601519) as a stock to avoid entirely with its 18.6x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

View our latest analysis for Shanghai DZH

How Has Shanghai DZH Performed Recently?

We'd have to say that with no tangible growth over the last year, Shanghai DZH's revenue has been unimpressive. One possibility is that the P/S is high because investors think the benign revenue growth will improve 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?

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

If we review the last year of revenue, the company posted a result that saw barely any deviation from a year ago. Still, the latest three year period was better as it's delivered a decent 16% overall rise in revenue. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

This is in contrast to the rest of the industry, which is expected to grow by 27% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Shanghai DZH'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. 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

Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Our examination of Shanghai DZH 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. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. 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.

You should always think about risks. Case in point, we've spotted 1 warning sign for Shanghai DZH you should be aware of.

If these risks are making you reconsider your opinion on Shanghai DZH, 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.