There's Reason For Concern Over Hualan Group Co., Ltd.'s (SZSE:301027) Massive 47% Price Jump

Hualan Group Co., Ltd. (SZSE:301027) shareholders have had their patience rewarded with a 47% share price jump in the last month. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 11% in the last twelve months.

Following the firm bounce in price, given close to half the companies operating in China's Construction industry have price-to-sales ratios (or "P/S") below 1.2x, you may consider Hualan Group as a stock to potentially avoid with its 2.5x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

Check out our latest analysis for Hualan Group

What Does Hualan Group's P/S Mean For Shareholders?

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.

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.

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

In order to justify its P/S ratio, Hualan Group would need to produce impressive growth in excess of the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 12%. The last three years don't look nice either as the company has shrunk revenue by 45% 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 14% shows it's an unpleasant look.

With this in mind, we find it worrying that Hualan Group's P/S exceeds that of its industry peers. 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. 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?

Hualan Group's P/S is on the rise since its shares have risen strongly. 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.

Our examination of Hualan Group 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Having said that, be aware Hualan Group is showing 3 warning signs in our investment analysis, and 2 of those make us uncomfortable.

If you're unsure about the strength of Hualan Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.