There's Reason For Concern Over Shenzhen Original Advanced Compounds Co., Ltd.'s (SHSE:603991) Massive 30% Price Jump

Those holding Shenzhen Original Advanced Compounds Co., Ltd. (SHSE:603991) shares would be relieved that the share price has rebounded 30% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 15% over that time.

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 2x, you may consider Shenzhen Original Advanced Compounds as a stock to avoid entirely with its 9.7x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

View our latest analysis for Shenzhen Original Advanced Compounds

How Has Shenzhen Original Advanced Compounds Performed Recently?

Shenzhen Original Advanced Compounds certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. It seems that many are expecting the strong revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

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?

Shenzhen Original Advanced Compounds' 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.

Retrospectively, the last year delivered an exceptional 83% gain to the company's top line. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 9.1% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenues over that time.

In contrast to the company, the rest of the industry is expected to grow by 22% 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 Shenzhen Original Advanced Compounds' 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 Final Word

The strong share price surge has lead to Shenzhen Original Advanced Compounds' P/S soaring as well. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Shenzhen Original Advanced Compounds revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

It is also worth noting that we have found 3 warning signs for Shenzhen Original Advanced Compounds (2 are potentially serious!) that you need to take into consideration.

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.