Hualan Group Co., Ltd.'s (SZSE:301027) Shares May Have Run Too Fast Too Soon

When you see that almost half of the companies in the Construction industry in China have price-to-sales ratios (or "P/S") below 1.5x, Hualan Group Co., Ltd. (SZSE:301027) looks to be giving off some sell signals with its 3.1x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

See our latest analysis for Hualan Group

What Does Hualan Group's Recent Performance Look Like?

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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

Do Revenue Forecasts Match The High P/S Ratio?

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 19% 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 48% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 12% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Hualan Group'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. 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 We Can Learn From Hualan Group's P/S?

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

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. 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. 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.

Before you settle on your opinion, we've discovered 2 warning signs for Hualan Group that you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.