Unpleasant Surprises Could Be In Store For Chongqing Sanxia Paints Co., Ltd's (SZSE:000565) Shares

Chongqing Sanxia Paints Co., Ltd's (SZSE:000565) price-to-sales (or "P/S") ratio of 5.5x may look like a poor investment opportunity when you consider close to half the companies in the Chemicals industry in China have P/S ratios below 2.3x. 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 Chongqing Sanxia Paints

How Has Chongqing Sanxia Paints Performed Recently?

For example, consider that Chongqing Sanxia Paints' financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. If not, then existing shareholders may be quite nervous about the viability of the share price.

Although there are no analyst estimates available for Chongqing Sanxia Paints, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Chongqing Sanxia Paints would need to produce outstanding growth that's well in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 21%. As a result, revenue from three years ago have also fallen 19% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

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 Chongqing Sanxia Paints' P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Bottom Line On 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.

We've established that Chongqing Sanxia Paints currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Having said that, be aware Chongqing Sanxia Paints is showing 1 warning sign in our investment analysis, you should know about.

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.