There's Reason For Concern Over Shenzhen GuoHua Network Security Technology Co., Ltd.'s (SZSE:000004) Massive 30% Price Jump

Shenzhen GuoHua Network Security Technology Co., Ltd. (SZSE:000004) shares have had a really impressive month, gaining 30% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 36% in the last twelve months.

Following the firm bounce in price, Shenzhen GuoHua Network Security Technology may be sending strong sell signals at present with a price-to-sales (or "P/S") ratio of 15.8x, when you consider almost half of the companies in the Software industry in China have P/S ratios under 4.4x and even P/S lower than 2x aren't out of the ordinary. 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

For example, consider that Shenzhen GuoHua Network Security Technology's financial performance has been poor lately as its revenue has been in decline. 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

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.

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 41%. As a result, revenue from three years ago have also fallen 65% overall. 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 28% 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

Shares in Shenzhen GuoHua Network Security Technology have seen a strong upwards swing lately, which has really helped boost its P/S figure. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that Shenzhen GuoHua Network Security Technology currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. 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.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Shenzhen GuoHua Network Security Technology that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com