More Unpleasant Surprises Could Be In Store For Guangxi Hechi Chemical Co., Ltd's (SZSE:000953) Shares After Tumbling 33%

Guangxi Hechi Chemical Co., Ltd (SZSE:000953) shareholders that were waiting for something to happen have been dealt a blow with a 33% share price drop in the last month. For any long-term shareholders, the last month ends a year to forget by locking in a 56% share price decline.

Although its price has dipped substantially, given around half the companies in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2x, you may still consider Guangxi Hechi Chemical as a stock to avoid entirely with its 4.4x 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.

See our latest analysis for Guangxi Hechi Chemical

What Does Guangxi Hechi Chemical's P/S Mean For Shareholders?

Revenue has risen firmly for Guangxi Hechi Chemical recently, which is pleasing to see. One possibility is that the P/S ratio is high because investors think this respectable 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.

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

Is There Enough Revenue Growth Forecasted For Guangxi Hechi Chemical?

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

If we review the last year of revenue growth, the company posted a worthy increase of 8.0%. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 17% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 23% 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 Guangxi Hechi Chemical's 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 Final Word

Even after such a strong price drop, Guangxi Hechi Chemical's P/S still exceeds the industry median significantly. 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 Guangxi Hechi Chemical currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. 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.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for Guangxi Hechi Chemical with six simple checks.

If these risks are making you reconsider your opinion on Guangxi Hechi Chemical, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.