Hualan Group Co., Ltd.'s (SZSE:301027) 29% Share Price Plunge Could Signal Some Risk

Hualan Group Co., Ltd. (SZSE:301027) shares have had a horrible month, losing 29% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 35% share price drop.

In spite of the heavy fall in price, you could still be forgiven for thinking Hualan Group is a stock not worth researching with a price-to-sales ratios (or "P/S") of 1.8x, considering almost half the companies in China's Construction industry have P/S ratios below 1.1x. 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 Hualan Group

How Hualan Group Has Been Performing

As an illustration, revenue has deteriorated at Hualan Group over the last year, which is not ideal at all. 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 Hualan Group, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Hualan Group's Revenue Growth Trending?

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

Retrospectively, the last year delivered a frustrating 15% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 42% in total over the last three years. 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 15% shows it's an unpleasant look.

In light of this, it's alarming that Hualan Group'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. 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 Hualan Group's P/S Mean For Investors?

Hualan Group's P/S remain high even after its stock plunged. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Hualan Group currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Before you take the next step, you should know about the 4 warning signs for Hualan Group (3 can't be ignored!) that we have uncovered.

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.