Dalian Friendship (Group) Co., Ltd.'s (SZSE:000679) 29% Share Price Surge Not Quite Adding Up

Despite an already strong run, Dalian Friendship (Group) Co., Ltd. (SZSE:000679) shares have been powering on, with a gain of 29% in the last thirty days. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 16% over that time.

After such a large jump in price, when almost half of the companies in China's Multiline Retail industry have price-to-sales ratios (or "P/S") below 1.8x, you may consider Dalian Friendship (Group) as a stock not worth researching with its 10.6x 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.

Check out our latest analysis for Dalian Friendship (Group)

What Does Dalian Friendship (Group)'s P/S Mean For Shareholders?

The recent revenue growth at Dalian Friendship (Group) would have to be considered satisfactory if not spectacular. 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.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Dalian Friendship (Group) will help you shine a light on its historical performance.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Dalian Friendship (Group) would need to produce outstanding growth that's well in excess of the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 2.7% last year. However, this wasn't enough as the latest three year period has seen an unpleasant 16% overall drop in revenue. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 14% shows it's an unpleasant look.

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

The strong share price surge has lead to Dalian Friendship (Group)'s P/S soaring as well. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Dalian Friendship (Group) 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.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Dalian Friendship (Group) with six simple checks will allow you to discover any risks that could be an issue.

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.