ENC Digital Technology Co., Ltd's (SHSE:603869) Shares Climb 30% But Its Business Is Yet to Catch Up

ENC Digital Technology Co., Ltd (SHSE:603869) shareholders are no doubt pleased to see that the share price has bounced 30% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 17% over that time.

After such a large jump in price, you could be forgiven for thinking ENC Digital Technology is a stock not worth researching with a price-to-sales ratios (or "P/S") of 4.6x, considering almost half the companies in China's IT industry have P/S ratios below 3.7x. 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 ENC Digital Technology

How ENC Digital Technology Has Been Performing

For instance, ENC Digital Technology's receding revenue in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on ENC Digital Technology will help you shine a light on its historical performance.

Do Revenue Forecasts Match The High P/S Ratio?

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

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 29%. As a result, revenue from three years ago have also fallen 57% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 40% shows it's an unpleasant look.

With this information, we find it concerning that ENC Digital Technology is trading at a P/S higher than the industry. 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.

The Final Word

ENC Digital Technology shares have taken a big step in a northerly direction, but its P/S is elevated as a result. 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.

We've established that ENC Digital Technology currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

Plus, you should also learn about this 1 warning sign we've spotted with ENC Digital Technology.

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.