Shanghai Information2 Software Inc.'s (SHSE:688435) Shares Climb 76% But Its Business Is Yet to Catch Up

Shanghai Information2 Software Inc. (SHSE:688435) shareholders would be excited to see that the share price has had a great month, posting a 76% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 75%.

Following the firm bounce in price, given around half the companies in China's Software industry have price-to-sales ratios (or "P/S") below 7.6x, you may consider Shanghai Information2 Software as a stock to avoid entirely with its 18.4x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for Shanghai Information2 Software

How Has Shanghai Information2 Software Performed Recently?

Shanghai Information2 Software has been doing a decent job lately as it's been growing revenue at a reasonable pace. 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. If not, then existing shareholders may be a little nervous about the viability of the share price.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Shanghai Information2 Software will help you shine a light on its historical performance.

How Is Shanghai Information2 Software's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shanghai Information2 Software's to be considered reasonable.

Retrospectively, the last year delivered a decent 7.3% gain to the company's revenues. The latest three year period has also seen an excellent 44% overall rise in revenue, aided somewhat by its short-term performance. So we can start by confirming that the company has done a great job of growing revenues over that time.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 28% shows it's noticeably less attractive.

With this information, we find it concerning that Shanghai Information2 Software is trading at a P/S higher than the industry. 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 strong share price surge has lead to Shanghai Information2 Software's P/S soaring as well. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

The fact that Shanghai Information2 Software currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. 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.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Shanghai Information2 Software (2 can't be ignored) you should be aware of.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.