Cnlight Co.,Ltd's (SZSE:002076) Shares Climb 36% But Its Business Is Yet to Catch Up

Cnlight Co.,Ltd (SZSE:002076) shares have continued their recent momentum with a 36% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 37% in the last year.

Since its price has surged higher, given around half the companies in China's Electrical industry have price-to-sales ratios (or "P/S") below 2.5x, you may consider CnlightLtd as a stock to avoid entirely with its 20.5x 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.

Check out our latest analysis for CnlightLtd

What Does CnlightLtd's P/S Mean For Shareholders?

Revenue has risen at a steady rate over the last year for CnlightLtd, which is generally not a bad outcome. Perhaps the market believes the recent revenue performance is strong enough to outperform the industry, which has inflated the P/S ratio. 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 CnlightLtd's earnings, revenue and cash flow.

How Is CnlightLtd's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like CnlightLtd's to be considered reasonable.

Taking a look back first, we see that the company managed to grow revenues by a handy 3.6% last year. Still, lamentably revenue has fallen 25% in aggregate from three years ago, which is disappointing. 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 25% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that CnlightLtd's P/S sits above the majority of other companies. 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 Key Takeaway

CnlightLtd'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 CnlightLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with CnlightLtd, and understanding should be part of your investment process.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.