Sunlour Pigment Co.,Ltd's (SZSE:301036) 55% Share Price Surge Not Quite Adding Up

Sunlour Pigment Co.,Ltd (SZSE:301036) shares have continued their recent momentum with a 55% gain in the last month alone. The annual gain comes to 123% following the latest surge, making investors sit up and take notice.

After such a large jump in price, given close to half the companies operating in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2.2x, you may consider Sunlour PigmentLtd as a stock to potentially avoid with its 3x 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.

See our latest analysis for Sunlour PigmentLtd

How Sunlour PigmentLtd Has Been Performing

Revenue has risen firmly for Sunlour PigmentLtd recently, which is pleasing to see. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Sunlour PigmentLtd's earnings, revenue and cash flow.

What Are Revenue Growth Metrics Telling Us About The High P/S?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Sunlour PigmentLtd's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 26% last year. The latest three year period has also seen a 8.2% overall rise in revenue, aided extensively by its short-term performance. Accordingly, shareholders would have probably been satisfied with the medium-term rates of revenue growth.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 21% shows it's noticeably less attractive.

With this in mind, we find it worrying that Sunlour PigmentLtd's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 Key Takeaway

The large bounce in Sunlour PigmentLtd's 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.

Our examination of Sunlour PigmentLtd revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely 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 3 warning signs for Sunlour PigmentLtd (of which 2 are significant!) 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.

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.