Some Confidence Is Lacking In Shanghai Hongda New Material Co., Ltd. (SZSE:002211) As Shares Slide 30%

Shanghai Hongda New Material Co., Ltd. (SZSE:002211) shareholders that were waiting for something to happen have been dealt a blow with a 30% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 29% in that time.

Although its price has dipped substantially, you could still be forgiven for thinking Shanghai Hongda New Material is a stock not worth researching with a price-to-sales ratios (or "P/S") of 4x, considering almost half the companies in China's Chemicals industry have P/S ratios below 2x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

See our latest analysis for Shanghai Hongda New Material

How Has Shanghai Hongda New Material Performed Recently?

As an illustration, revenue has deteriorated at Shanghai Hongda New Material over the last year, which is not ideal at all. 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 Shanghai Hongda New Material, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

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

There's an inherent assumption that a company should outperform the industry for P/S ratios like Shanghai Hongda New Material's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 41% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 76% in aggregate. 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 23% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Shanghai Hongda New Material is trading at a P/S higher than the industry. 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. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

What We Can Learn From Shanghai Hongda New Material's P/S?

Despite the recent share price weakness, Shanghai Hongda New Material's P/S remains higher than most other companies in the industry. 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.

We've established that Shanghai Hongda New Material 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Having said that, be aware Shanghai Hongda New Material is showing 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable.

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.