Unfortunately for some shareholders, the Shenzhen Original Advanced Compounds Co., Ltd. (SHSE:603991) share price has dived 27% in the last thirty days, prolonging recent pain. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 29% share price drop.

Even after such a large drop in price, given around half the companies in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2x, you may still consider Shenzhen Original Advanced Compounds as a stock to avoid entirely with its 9.9x 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.

How Has Shenzhen Original Advanced Compounds Performed Recently?

Recent times have been quite advantageous for Shenzhen Original Advanced Compounds as its revenue has been rising very briskly. 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.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as Shenzhen Original Advanced Compounds' is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered an exceptional 113% gain to the company's top line. However, this wasn't enough as the latest three year period has seen the company endure a nasty 44% drop in revenue in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 20% shows it's an unpleasant look.

With this information, we find it concerning that Shenzhen Original Advanced Compounds is trading at a P/S higher than the industry. 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.

What Does Shenzhen Original Advanced Compounds' P/S Mean For Investors?

Shenzhen Original Advanced Compounds' shares may have suffered, but its P/S remains high. 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.

We've established that Shenzhen Original Advanced Compounds currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

It is also worth noting that we have found 2 warning signs for Shenzhen Original Advanced Compounds that you need to take into consideration.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.