What Shanghai Hongda New Material Co., Ltd.'s (SZSE:002211) 33% Share Price Gain Is Not Telling You

Shanghai Hongda New Material Co., Ltd. (SZSE:002211) shares have continued their recent momentum with a 33% gain in the last month alone. Looking further back, the 19% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

After such a large jump in price, you could 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 7.4x, considering almost half the companies in China's Chemicals industry have P/S ratios below 2.5x. 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.

View our latest analysis for Shanghai Hongda New Material

How Has Shanghai Hongda New Material Performed Recently?

Shanghai Hongda New Material has been doing a good job lately as it's been growing revenue at a solid pace. 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.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Shanghai Hongda New Material would need to produce outstanding growth that's well in excess of the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 9.2% last year. However, this wasn't enough as the latest three year period has seen an unpleasant 58% overall drop in revenue. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 25% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Shanghai Hongda New Material's P/S sits above the majority of other companies. 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.

The Bottom Line On Shanghai Hongda New Material's P/S

Shanghai Hongda New Material's P/S has grown nicely over the last month thanks to a handy boost in the share price. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

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.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Shanghai Hongda New Material you should know about.

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.

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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.