There's Reason For Concern Over Xiamen Zhongchuang Environmental Technology Co., Ltd's (SZSE:300056) Massive 33% Price Jump

Despite an already strong run, Xiamen Zhongchuang Environmental Technology Co., Ltd (SZSE:300056) shares have been powering on, with a gain of 33% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 58% in the last year.

Following the firm bounce in price, given around half the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.7x, you may consider Xiamen Zhongchuang Environmental Technology as a stock to avoid entirely with its 7.8x 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.

View our latest analysis for Xiamen Zhongchuang Environmental Technology

How Xiamen Zhongchuang Environmental Technology Has Been Performing

For example, consider that Xiamen Zhongchuang Environmental Technology's financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. However, if this isn't the case, investors might get caught out paying too much for the stock.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Xiamen Zhongchuang Environmental Technology 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, Xiamen Zhongchuang Environmental Technology 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 28%. The last three years don't look nice either as the company has shrunk revenue by 70% in aggregate. 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 25% shows it's an unpleasant look.

With this in mind, we find it worrying that Xiamen Zhongchuang Environmental Technology's P/S exceeds that of its industry peers. 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

The strong share price surge has lead to Xiamen Zhongchuang Environmental Technology's P/S soaring as well. 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.

Our examination of Xiamen Zhongchuang Environmental Technology 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.

There are also other vital risk factors to consider and we've discovered 2 warning signs for Xiamen Zhongchuang Environmental Technology (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.