Guangdong Rongtai Industry Co.,Ltd's (SHSE:600589) Shares Climb 31% But Its Business Is Yet to Catch Up

Those holding Guangdong Rongtai Industry Co.,Ltd (SHSE:600589) shares would be relieved that the share price has rebounded 31% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Looking back a bit further, it's encouraging to see the stock is up 64% in the last year.

After such a large jump in price, you could be forgiven for thinking Guangdong Rongtai IndustryLtd is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 14.4x, considering almost half the companies in China's Chemicals industry have P/S ratios below 2x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Guangdong Rongtai IndustryLtd

How Guangdong Rongtai IndustryLtd Has Been Performing

With revenue growth that's exceedingly strong of late, Guangdong Rongtai IndustryLtd has been doing very well. The P/S ratio is probably high because investors think this strong revenue growth will be enough to outperform the broader industry in the near future. 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 Guangdong Rongtai IndustryLtd's earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

Guangdong Rongtai IndustryLtd's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Taking a look back first, we see that the company grew revenue by an impressive 39% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 65% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenues over that time.

Comparing that to the industry, which is predicted to deliver 25% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Guangdong Rongtai IndustryLtd'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 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 Key Takeaway

Guangdong Rongtai IndustryLtd's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

We've established that Guangdong Rongtai IndustryLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. 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.

Plus, you should also learn about these 5 warning signs we've spotted with Guangdong Rongtai IndustryLtd (including 4 which can't be ignored).

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.