To the annoyance of some shareholders, Zhongtong Guomai Communication Co., Ltd. (SHSE:603559) shares are down a considerable 28% in the last month, which continues a horrid run for the company. For any long-term shareholders, the last month ends a year to forget by locking in a 69% share price decline.

After such a large drop in price, Zhongtong Guomai Communication may be sending buy signals at present with its price-to-sales (or "P/S") ratio of 1.4x, considering almost half of all companies in the IT industry in China have P/S ratios greater than 3.1x and even P/S higher than 7x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/S.

What Does Zhongtong Guomai Communication's Recent Performance Look Like?

As an illustration, revenue has deteriorated at Zhongtong Guomai Communication over the last year, which is not ideal at all. Perhaps the market believes the recent revenue performance isn't good enough to keep up the industry, causing the P/S ratio to suffer. Those who are bullish on Zhongtong Guomai Communication will be hoping that this isn't the case so that they can pick up the stock at a lower valuation.

How Is Zhongtong Guomai Communication's Revenue Growth Trending?

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

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 18%. The last three years don't look nice either as the company has shrunk revenue by 48% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 34% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we understand why Zhongtong Guomai Communication's P/S is lower than most of its industry peers. 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. Even just maintaining these prices could be difficult to achieve as recent revenue trends are already weighing down the shares.

The Key Takeaway

Zhongtong Guomai Communication's recently weak share price has pulled its P/S back below other IT companies. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

As we suspected, our examination of Zhongtong Guomai Communication 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. If recent medium-term revenue trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Zhongtong Guomai Communication (at least 1 which makes us a bit uncomfortable), and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Zhongtong Guomai Communication, explore our interactive list of high quality stocks to get an idea of what else is out there.

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.