Shenzhen GuoHua Network Security Technology Co., Ltd.'s (SZSE:000004) 27% Share Price Surge Not Quite Adding Up

Shenzhen GuoHua Network Security Technology Co., Ltd. (SZSE:000004) shareholders have had their patience rewarded with a 27% share price jump in the last month. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 20% over that time.

After such a large jump in price, Shenzhen GuoHua Network Security Technology may be sending very bearish signals at the moment with a price-to-sales (or "P/S") ratio of 15.2x, since almost half of all companies in the Software industry in China have P/S ratios under 4.2x and even P/S lower than 2x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for Shenzhen GuoHua Network Security Technology

How Shenzhen GuoHua Network Security Technology Has Been Performing

As an illustration, revenue has deteriorated at Shenzhen GuoHua Network Security Technology over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do 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 Shenzhen GuoHua Network Security Technology will help you shine a light on its historical performance.

Is There Enough Revenue Growth Forecasted For Shenzhen GuoHua Network Security Technology?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shenzhen GuoHua Network Security 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 34%. The last three years don't look nice either as the company has shrunk revenue by 64% in aggregate. 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 26% shows it's an unpleasant look.

With this information, we find it concerning that Shenzhen GuoHua Network Security 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 Key Takeaway

The strong share price surge has lead to Shenzhen GuoHua Network Security Technology's P/S soaring as well. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

Our examination of Shenzhen GuoHua Network Security Technology 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. 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.

It is also worth noting that we have found 2 warning signs for Shenzhen GuoHua Network Security Technology that you need to take into consideration.

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.