Essence Fastening Systems (Shanghai) Co., Ltd.'s (SZSE:301005) 29% Price Boost Is Out Of Tune With Revenues

Essence Fastening Systems (Shanghai) Co., Ltd. (SZSE:301005) shares have had a really impressive month, gaining 29% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 31%.

Since its price has surged higher, you could be forgiven for thinking Essence Fastening Systems (Shanghai) is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 7.4x, considering almost half the companies in China's Auto Components industry have P/S ratios below 2.3x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for Essence Fastening Systems (Shanghai)

How Essence Fastening Systems (Shanghai) Has Been Performing

Revenue has risen firmly for Essence Fastening Systems (Shanghai) recently, which is pleasing to see. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. If not, then existing shareholders may be a little nervous about the viability of the share price.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Essence Fastening Systems (Shanghai) will help you shine a light on its historical performance.

How Is Essence Fastening Systems (Shanghai)'s Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Essence Fastening Systems (Shanghai)'s to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 7.7%. The latest three year period has also seen an excellent 37% 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 25% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Essence Fastening Systems (Shanghai) 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.

The Final Word

Shares in Essence Fastening Systems (Shanghai) have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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 Essence Fastening Systems (Shanghai) 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 observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. 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.

You should always think about risks. Case in point, we've spotted 4 warning signs for Essence Fastening Systems (Shanghai) you should be aware of, and 1 of them doesn't sit too well with us.

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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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.