What Hangzhou Zhongheng Electric Co., Ltd's (SZSE:002364) 26% Share Price Gain Is Not Telling You

Despite an already strong run, Hangzhou Zhongheng Electric Co., Ltd (SZSE:002364) shares have been powering on, with a gain of 26% in the last thirty days. The annual gain comes to 185% following the latest surge, making investors sit up and take notice.

After such a large jump in price, you could be forgiven for thinking Hangzhou Zhongheng Electric is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 5.3x, considering almost half the companies in China's Electrical industry have P/S ratios below 2.6x. 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 Hangzhou Zhongheng Electric

How Hangzhou Zhongheng Electric Has Been Performing

The revenue growth achieved at Hangzhou Zhongheng Electric over the last year would be more than acceptable for most companies. 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. If not, then existing shareholders may be a little nervous about the viability of the share price.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Hangzhou Zhongheng Electric will help you shine a light on its historical performance.

Is There Enough Revenue Growth Forecasted For Hangzhou Zhongheng Electric?

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

If we review the last year of revenue growth, the company posted a worthy increase of 12%. Although, the latest three year period in total hasn't been as good as it didn't manage to provide any growth at all. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 25% shows it's noticeably less attractive.

With this in mind, we find it worrying that Hangzhou Zhongheng Electric'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. 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 Final Word

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

The fact that Hangzhou Zhongheng Electric currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. 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. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Plus, you should also learn about these 3 warning signs we've spotted with Hangzhou Zhongheng Electric (including 2 which don't sit too well with us).

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.