Optimistic Investors Push North Chemical Industries Co., Ltd. (SZSE:002246) Shares Up 34% But Growth Is Lacking

Despite an already strong run, North Chemical Industries Co., Ltd. (SZSE:002246) shares have been powering on, with a gain of 34% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 35% in the last year.

Following the firm bounce in price, given close to half the companies operating in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2.1x, you may consider North Chemical Industries as a stock to potentially avoid with its 2.9x 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 as high as it is.

View our latest analysis for North Chemical Industries

How Has North Chemical Industries Performed Recently?

For instance, North Chemical Industries' receding revenue in recent times would have to be some food for thought. One possibility is that the P/S is high because investors think the company will still do 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 North Chemical Industries will help you shine a light on its historical performance.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as high as North Chemical Industries' is when the company's growth is on track to outshine the industry.

Retrospectively, the last year delivered a frustrating 8.3% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 22% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 21% 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 North Chemical Industries' P/S exceeds that of its industry peers. 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 Does North Chemical Industries' P/S Mean For Investors?

The large bounce in North Chemical Industries' shares has lifted the company's P/S handsomely. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that North Chemical Industries 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.

And what about other risks? Every company has them, and we've spotted 2 warning signs for North Chemical Industries (of which 1 is a bit unpleasant!) you should know about.

If you're unsure about the strength of North Chemical Industries' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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.