What North Chemical Industries Co., Ltd.'s (SZSE:002246) 34% Share Price Gain Is Not Telling You

North Chemical Industries Co., Ltd. (SZSE:002246) shares have continued their recent momentum with a 34% gain in the last month alone. Taking a wider view, although not as strong as the last month, the full year gain of 19% is also fairly reasonable.

Following the firm bounce in price, when almost half of the companies in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2.2x, you may consider North Chemical Industries as a stock probably not worth researching with its 3x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

Check out our latest analysis for North Chemical Industries

What Does North Chemical Industries' Recent Performance Look Like?

For example, consider that North Chemical Industries' financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. 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 14% decrease to the company's top line. As a result, revenue from three years ago have also fallen 18% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

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 in mind, we find it worrying that North Chemical Industries' 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. 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.

The Bottom Line On North Chemical Industries' P/S

The large bounce in North Chemical Industries' shares has lifted the company's P/S handsomely. 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 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.

Before you settle on your opinion, we've discovered 4 warning signs for North Chemical Industries (1 is significant!) that you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.