Shanghai Hongda New Material Co., Ltd. (SZSE:002211) Shares May Have Slumped 26% But Getting In Cheap Is Still Unlikely

Shanghai Hongda New Material Co., Ltd. (SZSE:002211) shares have had a horrible month, losing 26% after a relatively good period beforehand. Longer-term shareholders would now have taken a real hit with the stock declining 6.9% in the last year.

Although its price has dipped substantially, you could still be forgiven for thinking Shanghai Hongda New Material is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 5.2x, considering almost half the companies in China's Chemicals industry have P/S ratios below 2.3x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for Shanghai Hongda New Material

What Does Shanghai Hongda New Material's P/S Mean For Shareholders?

The revenue growth achieved at Shanghai Hongda New Material over the last year would be more than acceptable for most companies. It might be that many expect the respectable 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 Shanghai Hongda New Material will help you shine a light on its historical performance.

What Are Revenue Growth Metrics Telling Us About The High P/S?

The only time you'd be truly comfortable seeing a P/S as steep as Shanghai Hongda New Material's is when the company's growth is on track to outshine the industry decidedly.

If we review the last year of revenue growth, the company posted a worthy increase of 9.2%. Still, lamentably revenue has fallen 58% in aggregate from three years ago, which is disappointing. 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 24% 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 Shanghai Hongda New Material'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 Bottom Line On Shanghai Hongda New Material's P/S

Shanghai Hongda New Material's shares may have suffered, but its P/S remains high. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Shanghai Hongda New Material 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. 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. 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.

You should always think about risks. Case in point, we've spotted 1 warning sign for Shanghai Hongda New Material you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.