What Fujian Rongji Software Co., Ltd.'s (SZSE:002474) 27% Share Price Gain Is Not Telling You

Fujian Rongji Software Co., Ltd. (SZSE:002474) shareholders would be excited to see that the share price has had a great month, posting a 27% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 32% in the last twelve months.

Following the firm bounce in price, you could be forgiven for thinking Fujian Rongji Software is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 8.8x, considering almost half the companies in China's IT industry have P/S ratios below 3.7x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

See our latest analysis for Fujian Rongji Software

What Does Fujian Rongji Software's P/S Mean For Shareholders?

For example, consider that Fujian Rongji Software'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.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Fujian Rongji Software will help you shine a light on its historical performance.

Is There Enough Revenue Growth Forecasted For Fujian Rongji Software?

Fujian Rongji Software's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Retrospectively, the last year delivered a frustrating 44% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 55% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 19% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Fujian Rongji Software 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.

What We Can Learn From Fujian Rongji Software's P/S?

Fujian Rongji Software's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

Our examination of Fujian Rongji Software 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Plus, you should also learn about this 1 warning sign we've spotted with Fujian Rongji Software.

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.