What Fujian Rongji Software Co., Ltd.'s (SZSE:002474) 37% Share Price Gain Is Not Telling You

Those holding Fujian Rongji Software Co., Ltd. (SZSE:002474) shares would be relieved that the share price has rebounded 37% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 42% over that time.

Since its price has surged higher, given close to half the companies operating in China's IT industry have price-to-sales ratios (or "P/S") below 3.7x, you may consider Fujian Rongji Software as a stock to potentially avoid with its 5.5x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

Check out our latest analysis for Fujian Rongji Software

How Fujian Rongji Software Has Been Performing

As an illustration, revenue has deteriorated at Fujian Rongji Software 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. 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 Fujian Rongji Software's earnings, revenue and cash flow.

How Is Fujian Rongji Software's Revenue Growth Trending?

In order to justify its P/S ratio, Fujian Rongji Software would need to produce impressive growth 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 10%. As a result, revenue from three years ago have also fallen 17% 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 41% shows it's an unpleasant look.

With this in mind, we find it worrying that Fujian Rongji Software's P/S exceeds that of its industry peers. 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

Fujian Rongji Software shares have taken a big step in a northerly direction, but its P/S is elevated as a result. 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 Fujian Rongji Software 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. 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.

It is also worth noting that we have found 1 warning sign for Fujian Rongji Software that you need to take into consideration.

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.