Ronglian Group Ltd.'s (SZSE:002642) Share Price Boosted 26% But Its Business Prospects Need A Lift Too

Ronglian Group Ltd. (SZSE:002642) shares have had a really impressive month, gaining 26% after a shaky period beforehand. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

Although its price has surged higher, Ronglian Group's price-to-sales (or "P/S") ratio of 2x might still make it look like a buy right now compared to the IT industry in China, where around half of the companies have P/S ratios above 3.2x and even P/S above 7x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/S.

View our latest analysis for Ronglian Group

What Does Ronglian Group's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Ronglian Group over the last year, which is not ideal at all. Perhaps the market believes the recent revenue performance isn't good enough to keep up the industry, causing the P/S ratio to suffer. Those who are bullish on Ronglian Group will be hoping that this isn't the case so that they can pick up the stock at a lower valuation.

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 Ronglian Group's earnings, revenue and cash flow.

Is There Any Revenue Growth Forecasted For Ronglian Group?

In order to justify its P/S ratio, Ronglian Group would need to produce sluggish growth that's trailing the industry.

Retrospectively, the last year delivered a frustrating 37% decrease to the company's top line. As a result, revenue from three years ago have also fallen 32% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 25% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's understandable that Ronglian Group's P/S would sit below the majority of other companies. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. Even just maintaining these prices could be difficult to achieve as recent revenue trends are already weighing down the shares.

What We Can Learn From Ronglian Group's P/S?

Ronglian Group's stock price has surged recently, but its but its P/S still remains modest. 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 Ronglian Group confirms that the company's shrinking revenue over the past medium-term is a key factor in its low price-to-sales ratio, given the industry is projected to grow. Right now shareholders are accepting the low P/S as they concede future revenue probably won't provide any pleasant surprises either. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Ronglian Group with six simple checks will allow you to discover any risks that could be an issue.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.