Chengdu Dahongli Machinery Co.,Ltd.'s (SZSE:300865) 25% Share Price Plunge Could Signal Some Risk

Chengdu Dahongli Machinery Co.,Ltd. (SZSE:300865) shares have retraced a considerable 25% in the last month, reversing a fair amount of their solid recent performance. Longer-term shareholders would now have taken a real hit with the stock declining 3.3% in the last year.

Although its price has dipped substantially, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 3x, you may still consider Chengdu Dahongli MachineryLtd as a stock probably not worth researching with its 3.6x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Chengdu Dahongli MachineryLtd

How Chengdu Dahongli MachineryLtd Has Been Performing

Recent times have been quite advantageous for Chengdu Dahongli MachineryLtd as its revenue has been rising very briskly. It seems that many are expecting the strong revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. 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 Chengdu Dahongli MachineryLtd, 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 Chengdu Dahongli MachineryLtd?

The only time you'd be truly comfortable seeing a P/S as high as Chengdu Dahongli MachineryLtd's is when the company's growth is on track to outshine the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 59%. However, this wasn't enough as the latest three year period has seen the company endure a nasty 20% drop in revenue in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 22% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Chengdu Dahongli MachineryLtd is trading at a P/S higher than the industry. 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. 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.

What Does Chengdu Dahongli MachineryLtd's P/S Mean For Investors?

Chengdu Dahongli MachineryLtd's P/S remain high even after its stock plunged. 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.

We've established that Chengdu Dahongli MachineryLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. 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.

Having said that, be aware Chengdu Dahongli MachineryLtd is showing 2 warning signs in our investment analysis, you should know about.

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.