There's Reason For Concern Over Sichuan Hongda Co.,Ltd's (SHSE:600331) Massive 28% Price Jump

Sichuan Hongda Co.,Ltd (SHSE:600331) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 98% in the last year.

After such a large jump in price, when almost half of the companies in China's Metals and Mining industry have price-to-sales ratios (or "P/S") below 1.3x, you may consider Sichuan HongdaLtd as a stock not worth researching with its 4.3x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

View our latest analysis for Sichuan HongdaLtd

What Does Sichuan HongdaLtd's Recent Performance Look Like?

Sichuan HongdaLtd has been doing a good job lately as it's been growing revenue at a solid pace. It might be that many expect the respectable 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 Sichuan HongdaLtd'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 steep as Sichuan HongdaLtd's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered a decent 13% gain to the company's revenues. Pleasingly, revenue has also lifted 37% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been superb for the company.

Comparing that to the industry, which is predicted to deliver 14% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

In light of this, it's alarming that Sichuan HongdaLtd's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 Bottom Line On Sichuan HongdaLtd's P/S

The strong share price surge has lead to Sichuan HongdaLtd's P/S soaring as well. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of Sichuan HongdaLtd 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 see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

Many other vital risk factors can be found on the company's balance sheet. Take a look at our free balance sheet analysis for Sichuan HongdaLtd with six simple checks on some of these key factors.

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.