There's Reason For Concern Over Shenzhen GuoHua Network Security Technology Co., Ltd.'s (SZSE:000004) Massive 36% Price Jump

Those holding Shenzhen GuoHua Network Security Technology Co., Ltd. (SZSE:000004) shares would be relieved that the share price has rebounded 36% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. The last 30 days bring the annual gain to a very sharp 40%.

Since its price has surged higher, when almost half of the companies in China's Software industry have price-to-sales ratios (or "P/S") below 5.2x, you may consider Shenzhen GuoHua Network Security Technology as a stock not worth researching with its 11.3x 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.

View 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.

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 Shenzhen GuoHua Network Security Technology's earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as Shenzhen GuoHua Network Security Technology's is when the company's growth is on track to outshine the industry decidedly.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 21%. Regardless, revenue has managed to lift by a handy 11% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable for the company.

Comparing that to the industry, which is predicted to deliver 33% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

In light of this, it's alarming that Shenzhen GuoHua Network Security Technology's P/S sits above the majority of other companies. 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. 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 Final Word

Shenzhen GuoHua Network Security Technology's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

The fact that Shenzhen GuoHua Network Security Technology 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. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. 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.

Before you take the next step, you should know about the 2 warning signs for Shenzhen GuoHua Network Security Technology (1 shouldn't be ignored!) that we have uncovered.

If you're unsure about the strength of Shenzhen GuoHua Network Security Technology's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.