Chengdu Dahongli Machinery Co.,Ltd. (SZSE:300865) Stock Rockets 43% As Investors Are Less Pessimistic Than Expected

Chengdu Dahongli Machinery Co.,Ltd. (SZSE:300865) shares have had a really impressive month, gaining 43% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 14% in the last twelve months.

Following the firm bounce in price, you could be forgiven for thinking Chengdu Dahongli MachineryLtd is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.4x, considering almost half the companies in China's Machinery industry have P/S ratios below 2.8x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

Check out our latest analysis for Chengdu Dahongli MachineryLtd

What Does Chengdu Dahongli MachineryLtd's Recent Performance Look Like?

Chengdu Dahongli MachineryLtd certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. The P/S ratio is probably high because investors think this strong revenue growth will be 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.

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

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

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

Taking a look back first, we see that the company grew revenue by an impressive 50% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 26% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Comparing that to the industry, which is predicted to deliver 23% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Chengdu Dahongli MachineryLtd's P/S sits above the majority of other companies. 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 Bottom Line On Chengdu Dahongli MachineryLtd's P/S

Chengdu Dahongli MachineryLtd shares have taken a big step in a northerly direction, but its P/S is elevated as a result. 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 Chengdu Dahongli MachineryLtd 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. 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.

Before you take the next step, you should know about the 2 warning signs for Chengdu Dahongli MachineryLtd that we have uncovered.

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).

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.