Optimistic Investors Push Zhe Jiang Headman Machinery Co.,Ltd. (SHSE:688577) Shares Up 26% But Growth Is Lacking

Zhe Jiang Headman Machinery Co.,Ltd. (SHSE:688577) shares have continued their recent momentum with a 26% gain in the last month alone. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 10% in the last twelve months.

Following the firm bounce in price, you could be forgiven for thinking Zhe Jiang Headman MachineryLtd is a stock not worth researching with a price-to-sales ratios (or "P/S") of 5.2x, considering almost half the companies in China's Machinery industry have P/S ratios below 3.3x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

Check out our latest analysis for Zhe Jiang Headman MachineryLtd

How Zhe Jiang Headman MachineryLtd Has Been Performing

The revenue growth achieved at Zhe Jiang Headman MachineryLtd over the last year would be more than acceptable for most companies. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders may be a little nervous about the viability of the share price.

Although there are no analyst estimates available for Zhe Jiang Headman MachineryLtd, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Zhe Jiang Headman MachineryLtd would need to produce impressive growth in excess of the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 15% last year. Pleasingly, revenue has also lifted 39% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 23% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that Zhe Jiang Headman MachineryLtd's P/S exceeds that of its industry peers. 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.

The Key Takeaway

The large bounce in Zhe Jiang Headman MachineryLtd's shares has lifted the company's P/S handsomely. 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.

Our examination of Zhe Jiang Headman MachineryLtd 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 see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

You need to take note of risks, for example - Zhe Jiang Headman MachineryLtd has 6 warning signs (and 2 which are a bit concerning) we think you should know about.

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.