Dalian Friendship (Group) Co., Ltd. (SZSE:000679) Stock Rockets 26% As Investors Are Less Pessimistic Than Expected

Dalian Friendship (Group) Co., Ltd. (SZSE:000679) shares have continued their recent momentum with a 26% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 81% in the last year.

Following the firm bounce in price, you could be forgiven for thinking Dalian Friendship (Group) is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 16.4x, considering almost half the companies in China's Multiline Retail industry have P/S ratios below 2.1x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

Check out our latest analysis for Dalian Friendship (Group)

What Does Dalian Friendship (Group)'s Recent Performance Look Like?

Revenue has risen at a steady rate over the last year for Dalian Friendship (Group), which is generally not a bad outcome. It might be that many expect the reasonable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. 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 Dalian Friendship (Group)'s earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Dalian Friendship (Group)'s to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 2.7%. However, this wasn't enough as the latest three year period has seen an unpleasant 16% overall drop in revenue. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 9.0% 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 Dalian Friendship (Group)'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 Dalian Friendship (Group)'s P/S

Shares in Dalian Friendship (Group) have seen a strong upwards swing lately, which has really helped boost its P/S figure. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've established that Dalian Friendship (Group) currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. 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.

You should always think about risks. Case in point, we've spotted 1 warning sign for Dalian Friendship (Group) you should be aware of.

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.