Shanghai New World Co., Ltd (SHSE:600628) May Have Run Too Fast Too Soon With Recent 29% Price Plummet

Shanghai New World Co., Ltd (SHSE:600628) shares have retraced a considerable 29% in the last month, reversing a fair amount of their solid recent performance. Looking back over the past twelve months the stock has been a solid performer regardless, with a gain of 11%.

Even after such a large drop in price, given close to half the companies operating in China's Pharmaceuticals industry have price-to-sales ratios (or "P/S") below 3.3x, you may still consider Shanghai New World as a stock to potentially avoid with its 4.5x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

Check out our latest analysis for Shanghai New World

What Does Shanghai New World's Recent Performance Look Like?

Revenue has risen at a steady rate over the last year for Shanghai New World, which is generally not a bad outcome. Perhaps the market believes the recent revenue performance is strong enough to outperform the industry, which has inflated the P/S ratio. 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 Shanghai New World will help you shine a light on its historical performance.

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 Shanghai New World's to be considered reasonable.

Taking a look back first, we see that the company managed to grow revenues by a handy 5.5% last year. Still, lamentably revenue has fallen 3.1% in aggregate from three years ago, which is disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 187% shows it's an unpleasant look.

In light of this, it's alarming that Shanghai New World's P/S sits above the majority of other companies. 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.

What Does Shanghai New World's P/S Mean For Investors?

Despite the recent share price weakness, Shanghai New World's P/S remains higher than most other companies in the industry. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Shanghai New World 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. 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. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Shanghai New World (at least 1 which is significant), and understanding them should be part of your investment process.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.