There's Reason For Concern Over Shanghai Hugong Electric Group Co.,Ltd.'s (SHSE:603131) Massive 32% Price Jump

Shanghai Hugong Electric Group Co.,Ltd. (SHSE:603131) shares have had a really impressive month, gaining 32% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 31% in the last year.

Following the firm bounce in price, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.4x, you may consider Shanghai Hugong Electric GroupLtd as a stock not worth researching with its 5x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

View our latest analysis for Shanghai Hugong Electric GroupLtd

How Shanghai Hugong Electric GroupLtd Has Been Performing

Shanghai Hugong Electric GroupLtd has been doing a good job lately as it's been growing revenue at a solid pace. 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.

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 Shanghai Hugong Electric GroupLtd's earnings, revenue and cash flow.

What Are Revenue Growth Metrics Telling Us About The High P/S?

In order to justify its P/S ratio, Shanghai Hugong Electric GroupLtd would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered a decent 13% gain to the company's revenues. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 11% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 22% shows it's an unpleasant look.

With this in mind, we find it worrying that Shanghai Hugong Electric GroupLtd'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. 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.

What We Can Learn From Shanghai Hugong Electric GroupLtd's P/S?

Shanghai Hugong Electric GroupLtd's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

We've established that Shanghai Hugong Electric GroupLtd 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.

You need to take note of risks, for example - Shanghai Hugong Electric GroupLtd has 2 warning signs (and 1 which is significant) we think you should know about.

If you're unsure about the strength of Shanghai Hugong Electric GroupLtd's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com