Shenzhen Original Advanced Compounds Co., Ltd.'s (SHSE:603991) 27% Share Price Surge Not Quite Adding Up

Shenzhen Original Advanced Compounds Co., Ltd. (SHSE:603991) shareholders are no doubt pleased to see that the share price has bounced 27% in the last month, although it is still struggling to make up recently lost ground. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 2.5% over the last year.

Following the firm bounce in price, given around half the companies in China's Chemicals industry have price-to-sales ratios (or "P/S") below 1.9x, you may consider Shenzhen Original Advanced Compounds as a stock to avoid entirely with its 13.6x 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.

Check out our latest analysis for Shenzhen Original Advanced Compounds

What Does Shenzhen Original Advanced Compounds' P/S Mean For Shareholders?

Shenzhen Original Advanced Compounds certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. 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 Shenzhen Original Advanced Compounds' 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, Shenzhen Original Advanced Compounds would need to produce outstanding growth that's well in excess of the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 113%. Still, revenue has fallen 44% in total from three years ago, which is quite disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 25% shows it's an unpleasant look.

In light of this, it's alarming that Shenzhen Original Advanced Compounds' P/S sits above the majority of other companies. 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.

What Does Shenzhen Original Advanced Compounds' P/S Mean For Investors?

Shares in Shenzhen Original Advanced Compounds have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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 Shenzhen Original Advanced Compounds 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.

It is also worth noting that we have found 2 warning signs for Shenzhen Original Advanced Compounds that you need to take into consideration.

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.