Shanghai Yanhua Smartech Group Co., Ltd.'s (SZSE:002178) 33% Share Price Surge Not Quite Adding Up

Shanghai Yanhua Smartech Group Co., Ltd. (SZSE:002178) shares have had a really impressive month, gaining 33% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 44%.

Since its price has surged higher, you could be forgiven for thinking Shanghai Yanhua Smartech Group is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 8.7x, considering almost half the companies in China's Construction industry have P/S ratios below 1.5x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Shanghai Yanhua Smartech Group

How Has Shanghai Yanhua Smartech Group Performed Recently?

For example, consider that Shanghai Yanhua Smartech Group's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. 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 Shanghai Yanhua Smartech Group will help you shine a light on its historical performance.

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

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 13%. As a result, revenue from three years ago have also fallen 22% overall. 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 12% shows it's an unpleasant look.

With this information, we find it concerning that Shanghai Yanhua Smartech Group is trading at a P/S higher than the industry. 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.

The Key Takeaway

Shares in Shanghai Yanhua Smartech Group have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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.

Our examination of Shanghai Yanhua Smartech Group revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Plus, you should also learn about these 2 warning signs we've spotted with Shanghai Yanhua Smartech Group.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.