Zhejiang Fenglong Electric Co., Ltd.'s (SZSE:002931) 27% Price Boost Is Out Of Tune With Revenues

Zhejiang Fenglong Electric Co., Ltd. (SZSE:002931) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. 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, you could be forgiven for thinking Zhejiang Fenglong Electric is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 7x, considering almost half the companies in China's Machinery industry have P/S ratios below 2.7x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for Zhejiang Fenglong Electric

How Zhejiang Fenglong Electric Has Been Performing

For example, consider that Zhejiang Fenglong Electric's financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

Is There Enough Revenue Growth Forecasted For Zhejiang Fenglong Electric?

Zhejiang Fenglong Electric's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 32%. This means it has also seen a slide in revenue over the longer-term as revenue is down 12% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 28% shows it's an unpleasant look.

In light of this, it's alarming that Zhejiang Fenglong Electric'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.

What Does Zhejiang Fenglong Electric's P/S Mean For Investors?

The strong share price surge has lead to Zhejiang Fenglong Electric's P/S soaring as well. 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 Zhejiang Fenglong Electric 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. 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.

It is also worth noting that we have found 5 warning signs for Zhejiang Fenglong Electric (1 shouldn't be ignored!) that you need to take into consideration.

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.

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

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.