HCR Co., Ltd's (SHSE:688500) Shares May Have Run Too Fast Too Soon

When close to half the companies in the Professional Services industry in China have price-to-sales ratios (or "P/S") below 2.5x, you may consider HCR Co., Ltd (SHSE:688500) as a stock to avoid entirely with its 4.8x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for HCR

How Has HCR Performed Recently?

HCR has been doing a decent job lately as it's been growing revenue at a reasonable pace. One possibility is that the P/S ratio is high because investors think this good revenue growth will be enough to outperform the broader industry in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on HCR's earnings, revenue and cash flow.

How Is HCR's Revenue Growth Trending?

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

Retrospectively, the last year delivered a decent 3.2% gain to the company's revenues. Revenue has also lifted 26% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been respectable for the company.

This is in contrast to the rest of the industry, which is expected to grow by 42% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that HCR's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates 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.

The Final Word

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of HCR revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for HCR that you should be aware of.

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).

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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.