There's Reason For Concern Over Henan Dayou Energy Co., Ltd's (SHSE:600403) Massive 30% Price Jump

Henan Dayou Energy Co., Ltd (SHSE:600403) shareholders would be excited to see that the share price has had a great month, posting a 30% gain and recovering from prior weakness. Notwithstanding the latest gain, the annual share price return of 5.4% isn't as impressive.

After such a large jump in price, you could be forgiven for thinking Henan Dayou Energy is a stock not worth researching with a price-to-sales ratios (or "P/S") of 1.7x, considering almost half the companies in China's Oil and Gas industry have P/S ratios below 1.2x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

Check out our latest analysis for Henan Dayou Energy

How Henan Dayou Energy Has Been Performing

As an illustration, revenue has deteriorated at Henan Dayou Energy over the last year, which is not ideal at all. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. 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 Henan Dayou Energy, 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, Henan Dayou Energy would need to produce impressive growth in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 21%. The last three years don't look nice either as the company has shrunk revenue by 39% 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 6.0% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Henan Dayou Energy is trading at a P/S higher than the industry. 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 Final Word

Henan Dayou Energy shares have taken a big step in a northerly direction, but its P/S is elevated as a result. 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.

We've established that Henan Dayou Energy 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.

Having said that, be aware Henan Dayou Energy is showing 1 warning sign in our investment analysis, you should know about.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.