To the annoyance of some shareholders, Hengfeng Information Technology Co., Ltd. (SZSE:300605) shares are down a considerable 28% in the last month, which continues a horrid run for the company. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 49% in that time.

In spite of the heavy fall in price, Hengfeng Information Technology may still be sending bullish signals at the moment with its price-to-sales (or "P/S") ratio of 2.6x, since almost half of all companies in the IT industry in China have P/S ratios greater than 3.2x and even P/S higher than 6x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/S.

What Does Hengfeng Information Technology's P/S Mean For Shareholders?

For instance, Hengfeng Information Technology's receding revenue in recent times would have to be some food for thought. It might be that many expect the disappointing revenue performance to continue or accelerate, which has repressed the P/S. Those who are bullish on Hengfeng Information Technology will be hoping that this isn't the case so that they can pick up the stock at a lower valuation.

Is There Any Revenue Growth Forecasted For Hengfeng Information Technology?

The only time you'd be truly comfortable seeing a P/S as low as Hengfeng Information Technology's is when the company's growth is on track to lag the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 19%. This means it has also seen a slide in revenue over the longer-term as revenue is down 2.6% in total over the last three years. 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 40% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we are not surprised that Hengfeng Information Technology is trading at a P/S lower than the industry. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

The Final Word

The southerly movements of Hengfeng Information Technology's shares means its P/S is now sitting at a pretty low level. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Hengfeng Information Technology revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

You should always think about risks. Case in point, we've spotted 5 warning signs for Hengfeng Information Technology you should be aware of, and 2 of them don't sit too well with us.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.