Chongqing Sanxia Paints Co., Ltd's (SZSE:000565) Shares May Have Run Too Fast Too Soon

When close to half the companies in the Chemicals industry in China have price-to-sales ratios (or "P/S") below 2x, you may consider Chongqing Sanxia Paints Co., Ltd (SZSE:000565) as a stock to potentially avoid with its 3.6x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

Check out our latest analysis for Chongqing Sanxia Paints

What Does Chongqing Sanxia Paints' Recent Performance Look Like?

The recent revenue growth at Chongqing Sanxia Paints would have to be considered satisfactory if not spectacular. It might be that many expect the reasonable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Chongqing Sanxia Paints will help you shine a light on its historical performance.

How Is Chongqing Sanxia Paints' Revenue Growth Trending?

In order to justify its P/S ratio, Chongqing Sanxia Paints would need to produce impressive growth in excess of the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 3.0% last year. The latest three year period has also seen a 15% overall rise in revenue, aided somewhat by its short-term performance. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

This is in contrast to the rest of the industry, which is expected to grow by 21% 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 Chongqing Sanxia Paints' 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.

What We Can Learn From Chongqing Sanxia Paints' P/S?

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 Chongqing Sanxia Paints 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. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Before you take the next step, you should know about the 1 warning sign for Chongqing Sanxia Paints that we have uncovered.

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.