Unpleasant Surprises Could Be In Store For Xi'an Catering Co., Ltd.'s (SZSE:000721) Shares

With a price-to-sales (or "P/S") ratio of 7.2x Xi'an Catering Co., Ltd. (SZSE:000721) may be sending bearish signals at the moment, given that almost half of all Hospitality companies in China have P/S ratios under 5.7x and even P/S lower than 2x are not unusual. 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 Xi'an Catering

How Xi'an Catering Has Been Performing

For example, consider that Xi'an Catering's financial performance has been pretty ordinary lately as revenue growth is non-existent. One possibility is that the P/S is high because investors think the benign revenue growth will improve 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.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Xi'an Catering 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 Xi'an Catering's is when the company's growth is on track to outshine the industry.

Taking a look back first, we see that there was hardly any revenue growth to speak of for the company over the past year. Still, the latest three year period was better as it's delivered a decent 27% overall rise in revenue. So it appears to us that the company has had a mixed result in terms of growing revenue over that time.

This is in contrast to the rest of the industry, which is expected to grow by 16% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this in mind, we find it worrying that Xi'an Catering'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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What Does Xi'an Catering's P/S Mean For Investors?

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 Xi'an Catering 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 observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. 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.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Xi'an Catering 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).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.