What Shanghai Dragon Corporation's (SHSE:600630) 28% Share Price Gain Is Not Telling You

Shanghai Dragon Corporation (SHSE:600630) shares have continued their recent momentum with a 28% gain in the last month alone. Looking further back, the 18% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

After such a large jump in price, you could be forgiven for thinking Shanghai Dragon is a stock not worth researching with a price-to-sales ratios (or "P/S") of 2.6x, considering almost half the companies in China's Luxury industry have P/S ratios below 1.6x. 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 Shanghai Dragon

How Has Shanghai Dragon Performed Recently?

The revenue growth achieved at Shanghai Dragon over the last year would be more than acceptable for most companies. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 Shanghai Dragon's earnings, revenue and cash flow.

Is There Enough Revenue Growth Forecasted For Shanghai Dragon?

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

Retrospectively, the last year delivered an exceptional 29% gain to the company's top line. However, this wasn't enough as the latest three year period has seen the company endure a nasty 45% 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 15% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Shanghai Dragon'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. 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.

The Key Takeaway

Shanghai Dragon's P/S is on the rise since its shares have risen strongly. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've established that Shanghai Dragon 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

You always need to take note of risks, for example - Shanghai Dragon has 1 warning sign we think 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.