Optimistic Investors Push Essence Fastening Systems (Shanghai) Co., Ltd. (SZSE:301005) Shares Up 40% But Growth Is Lacking

Essence Fastening Systems (Shanghai) Co., Ltd. (SZSE:301005) shares have had a really impressive month, gaining 40% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 49%.

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 7.5x, considering almost half the companies in China's Auto Components industry have P/S ratios below 2.2x. 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 Has Essence Fastening Systems (Shanghai) Performed Recently?

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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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?

The only time you'd be truly comfortable seeing a P/S as steep as Essence Fastening Systems (Shanghai)'s is when the company's growth is on track to outshine the industry decidedly.

Taking a look back first, we see that the company grew revenue by an impressive 20% last year. Pleasingly, revenue has also lifted 46% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been superb for the company.

This is in contrast to the rest of the industry, which is expected to grow by 23% 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. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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.

What We Can Learn From Essence Fastening Systems (Shanghai)'s P/S?

Shares in Essence Fastening Systems (Shanghai) have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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.

The fact that Essence Fastening Systems (Shanghai) 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. 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.

It is also worth noting that we have found 4 warning signs for Essence Fastening Systems (Shanghai) (1 is a bit unpleasant!) 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.