Daoming Optics&Chemical Co.,Ltd's (SZSE:002632) Shares Climb 37% But Its Business Is Yet to Catch Up

Daoming Optics&Chemical Co.,Ltd (SZSE:002632) shares have had a really impressive month, gaining 37% after a shaky period beforehand. Unfortunately, despite the strong performance over the last month, the full year gain of 7.1% isn't as attractive.

Following the firm bounce in price, you could be forgiven for thinking Daoming Optics&ChemicalLtd is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.8x, 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.

View our latest analysis for Daoming Optics&ChemicalLtd

What Does Daoming Optics&ChemicalLtd's P/S Mean For Shareholders?

Revenue has risen at a steady rate over the last year for Daoming Optics&ChemicalLtd, which is generally not a bad outcome. One possibility is that the P/S ratio is high because investors think this good revenue growth will be 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.

Although there are no analyst estimates available for Daoming Optics&ChemicalLtd, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Daoming Optics&ChemicalLtd's Revenue Growth Trending?

Daoming Optics&ChemicalLtd's P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 3.9% last year. However, this wasn't enough as the latest three year period has seen an unpleasant 1.3% 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.

With this in mind, we find it worrying that Daoming Optics&ChemicalLtd's 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.

The Bottom Line On Daoming Optics&ChemicalLtd's P/S

The large bounce in Daoming Optics&ChemicalLtd's shares has lifted the company's P/S handsomely. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Our examination of Daoming Optics&ChemicalLtd 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. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

You need to take note of risks, for example - Daoming Optics&ChemicalLtd has 2 warning signs (and 1 which is potentially serious) we think you should know about.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.