Qinghai Huading Industrial Co., Ltd.'s (SHSE:600243) 32% Share Price Surge Not Quite Adding Up

Despite an already strong run, Qinghai Huading Industrial Co., Ltd. (SHSE:600243) shares have been powering on, with a gain of 32% in the last thirty days. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 20% in the last twelve months.

Since its price has surged higher, you could be forgiven for thinking Qinghai Huading Industrial is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 5.9x, considering almost half the companies in China's Machinery industry have P/S ratios below 2.5x. 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 Qinghai Huading Industrial

What Does Qinghai Huading Industrial's P/S Mean For Shareholders?

For instance, Qinghai Huading Industrial's receding revenue in recent times would have to be some food for thought. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. However, if this isn't the case, investors might get caught out paying too much for the stock.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Qinghai Huading Industrial's earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

Qinghai Huading Industrial's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 29%. The last three years don't look nice either as the company has shrunk revenue by 52% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 23% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Qinghai Huading Industrial's P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

What We Can Learn From Qinghai Huading Industrial's P/S?

Qinghai Huading Industrial's P/S has grown nicely over the last month thanks to a handy boost in the share price. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've established that Qinghai Huading Industrial currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Qinghai Huading Industrial that you should be aware of.

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).

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.