What Jiangsu Zhengdan Chemical Industry Co., Ltd.'s (SZSE:300641) 36% Share Price Gain Is Not Telling You

Jiangsu Zhengdan Chemical Industry Co., Ltd. (SZSE:300641) shareholders are no doubt pleased to see that the share price has bounced 36% in the last month, although it is still struggling to make up recently lost ground. This latest share price bounce rounds out a remarkable 339% gain over the last twelve months.

Since its price has surged higher, given around half the companies in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2.2x, you may consider Jiangsu Zhengdan Chemical Industry as a stock to avoid entirely with its 5.9x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Jiangsu Zhengdan Chemical Industry

How Jiangsu Zhengdan Chemical Industry Has Been Performing

Recent times have been quite advantageous for Jiangsu Zhengdan Chemical Industry as its revenue has been rising very briskly. Perhaps the market is expecting future revenue performance to outperform the wider market, which has seemingly got people interested in the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

Although there are no analyst estimates available for Jiangsu Zhengdan Chemical Industry, 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?

The only time you'd be truly comfortable seeing a P/S as steep as Jiangsu Zhengdan Chemical Industry's is when the company's growth is on track to outshine the industry decidedly.

If we review the last year of revenue growth, the company posted a terrific increase of 33%. The latest three year period has also seen an excellent 39% overall rise in revenue, aided by its short-term performance. So we can start by confirming that the company has done a great job of growing revenue over that time.

This is in contrast to the rest of the industry, which is expected to grow by 22% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Jiangsu Zhengdan Chemical Industry's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What We Can Learn From Jiangsu Zhengdan Chemical Industry's P/S?

Jiangsu Zhengdan Chemical Industry's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

The fact that Jiangsu Zhengdan Chemical Industry currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Jiangsu Zhengdan Chemical Industry (2 are concerning!) that you need to be mindful 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.