Shenzhen Sea Star Technology Co.,Ltd's (SZSE:002137) 26% Share Price Surge Not Quite Adding Up

Despite an already strong run, Shenzhen Sea Star Technology Co.,Ltd (SZSE:002137) shares have been powering on, with a gain of 26% in the last thirty days. The last 30 days bring the annual gain to a very sharp 42%.

After such a large jump in price, Shenzhen Sea Star TechnologyLtd's price-to-sales (or "P/S") ratio of 8.5x might make it look like a sell right now compared to the wider Software industry in China, where around half of the companies have P/S ratios below 6.3x and even P/S below 3x are quite common. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Shenzhen Sea Star TechnologyLtd

How Shenzhen Sea Star TechnologyLtd Has Been Performing

Shenzhen Sea Star TechnologyLtd 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

Although there are no analyst estimates available for Shenzhen Sea Star TechnologyLtd, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

How Is Shenzhen Sea Star TechnologyLtd's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as high as Shenzhen Sea Star TechnologyLtd's is when the company's growth is on track to outshine the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 5.4%. However, this wasn't enough as the latest three year period has seen an unpleasant 20% overall drop in revenue. 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 26% shows it's an unpleasant look.

With this in mind, we find it worrying that Shenzhen Sea Star TechnologyLtd's P/S exceeds that of its industry peers. 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. 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 Final Word

The large bounce in Shenzhen Sea Star TechnologyLtd's shares has lifted the company's P/S handsomely. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Shenzhen Sea Star TechnologyLtd 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

We don't want to rain on the parade too much, but we did also find 3 warning signs for Shenzhen Sea Star TechnologyLtd (1 is concerning!) that you need to be mindful 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.