Guangzheng Eye Hospital Group Co.,Ltd.'s (SZSE:002524) 27% Share Price Surge Not Quite Adding Up

Guangzheng Eye Hospital Group Co.,Ltd. (SZSE:002524) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. Unfortunately, despite the strong performance over the last month, the full year gain of 2.2% isn't as attractive.

Following the firm bounce in price, given close to half the companies operating in China's Healthcare industry have price-to-sales ratios (or "P/S") below 1.8x, you may consider Guangzheng Eye Hospital GroupLtd as a stock to potentially avoid with its 2.5x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Guangzheng Eye Hospital GroupLtd

How Guangzheng Eye Hospital GroupLtd Has Been Performing

For instance, Guangzheng Eye Hospital GroupLtd's receding revenue in recent times would have to be some food for thought. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

Although there are no analyst estimates available for Guangzheng Eye Hospital GroupLtd, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Is There Enough Revenue Growth Forecasted For Guangzheng Eye Hospital GroupLtd?

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

Retrospectively, the last year delivered a frustrating 7.4% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 12% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 12% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Guangzheng Eye Hospital GroupLtd'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. 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 Key Takeaway

Guangzheng Eye Hospital GroupLtd shares have taken a big step in a northerly direction, but its P/S is elevated as a result. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that Guangzheng Eye Hospital GroupLtd 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. 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.

Before you take the next step, you should know about the 1 warning sign for Guangzheng Eye Hospital GroupLtd that we have uncovered.

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.