What Shenzhen GuoHua Network Security Technology Co., Ltd.'s (SZSE:000004) 26% Share Price Gain Is Not Telling You

Those holding Shenzhen GuoHua Network Security Technology Co., Ltd. (SZSE:000004) shares would be relieved that the share price has rebounded 26% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Taking a wider view, although not as strong as the last month, the full year gain of 12% is also fairly reasonable.

After such a large jump in price, given around half the companies in China's Software industry have price-to-sales ratios (or "P/S") below 8.1x, you may consider Shenzhen GuoHua Network Security Technology as a stock to avoid entirely with its 16.8x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

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. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. If not, then existing shareholders may be quite 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 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?

In order to justify its P/S ratio, Shenzhen GuoHua Network Security Technology would need to produce outstanding growth that's well in excess of the industry.

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 35%. This means it has also seen a slide in revenue over the longer-term as revenue is down 65% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

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. 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

Shenzhen GuoHua Network Security Technology's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shenzhen GuoHua Network Security Technology, and understanding these should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.