Dalian Friendship (Group) Co., Ltd. (SZSE:000679) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 36% share price drop.

Even after such a large drop in price, given around half the companies in China's Multiline Retail industry have price-to-sales ratios (or "P/S") below 1.6x, you may still consider Dalian Friendship (Group) as a stock to avoid entirely with its 7.3x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Has Dalian Friendship (Group) Performed Recently?

Dalian Friendship (Group) has been doing a good job lately as it's been growing revenue at a solid pace. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Dalian Friendship (Group)'s Revenue Growth Trending?

In order to justify its P/S ratio, Dalian Friendship (Group) would need to produce outstanding growth that's well in excess of the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 8.3%. The latest three year period has also seen an excellent 35% overall rise in revenue, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing revenues over that time.

This is in contrast to the rest of the industry, which is expected to grow by 17% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Dalian Friendship (Group) 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. 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

A significant share price dive has done very little to deflate Dalian Friendship (Group)'s very lofty P/S. 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.

The fact that Dalian Friendship (Group) currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely to support such positive sentiment for long. 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.

Many other vital risk factors can be found on the company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Dalian Friendship (Group) with six simple checks.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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