There's Reason For Concern Over Shenzhen Fenda Technology Co., Ltd.'s (SZSE:002681) Massive 26% Price Jump

Shenzhen Fenda Technology Co., Ltd. (SZSE:002681) shares have continued their recent momentum with a 26% gain in the last month alone. Unfortunately, despite the strong performance over the last month, the full year gain of 8.5% isn't as attractive.

After such a large jump in price, you could be forgiven for thinking Shenzhen Fenda Technology is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.5x, considering almost half the companies in China's Consumer Durables industry have P/S ratios below 2.1x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

See our latest analysis for Shenzhen Fenda Technology

What Does Shenzhen Fenda Technology's P/S Mean For Shareholders?

Revenue has risen at a steady rate over the last year for Shenzhen Fenda Technology, which is generally not a bad outcome. It might be that many expect the reasonable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. 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 Shenzhen Fenda Technology's earnings, revenue and cash flow.

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

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

If we review the last year of revenue growth, the company posted a worthy increase of 6.1%. However, this wasn't enough as the latest three year period has seen an unpleasant 26% overall drop in revenue. 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 11% shows it's an unpleasant look.

In light of this, it's alarming that Shenzhen Fenda Technology'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. 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 Bottom Line On Shenzhen Fenda Technology's P/S

The large bounce in Shenzhen Fenda Technology's shares has lifted the company's P/S handsomely. 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 Shenzhen Fenda Technology 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. 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.

Having said that, be aware Shenzhen Fenda Technology is showing 3 warning signs in our investment analysis, you should know about.

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.