Nanjing Chemical Fiber Co., Ltd.'s (SHSE:600889) Shares May Have Run Too Fast Too Soon

When you see that almost half of the companies in the Chemicals industry in China have price-to-sales ratios (or "P/S") below 1.9x, Nanjing Chemical Fiber Co., Ltd. (SHSE:600889) looks to be giving off some sell signals with its 3.3x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

Check out our latest analysis for Nanjing Chemical Fiber

How Has Nanjing Chemical Fiber Performed Recently?

For example, consider that Nanjing Chemical Fiber's financial performance has been pretty ordinary lately as revenue growth is non-existent. Perhaps the market believes that revenue growth will improve markedly over current levels, inflating the P/S ratio. 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 Nanjing Chemical Fiber's earnings, revenue and cash flow.

What Are Revenue Growth Metrics Telling Us About The High P/S?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Nanjing Chemical Fiber's to be considered reasonable.

Retrospectively, the last year delivered virtually the same number to the company's top line as the year before. Fortunately, a few good years before that means that it was still able to grow revenue by 27% in total over the last three years. Therefore, it's fair to say that revenue growth has been inconsistent recently for the company.

This is in contrast to the rest of the industry, which is expected to grow by 25% 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 Nanjing Chemical Fiber's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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.

The Bottom Line On Nanjing Chemical Fiber's P/S

While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

The fact that Nanjing Chemical Fiber currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. 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 the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

You should always think about risks. Case in point, we've spotted 3 warning signs for Nanjing Chemical Fiber you should be aware of, and 2 of them are significant.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.