Optimistic Investors Push Shanghai DragonNet Technology Co.,Ltd. (SZSE:300245) Shares Up 25% But Growth Is Lacking

Despite an already strong run, Shanghai DragonNet Technology Co.,Ltd. (SZSE:300245) shares have been powering on, with a gain of 25% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 35% in the last year.

After such a large jump in price, Shanghai DragonNet TechnologyLtd may be sending very bearish signals at the moment with a price-to-sales (or "P/S") ratio of 9.2x, since almost half of all companies in the IT industry in China have P/S ratios under 4.8x and even P/S lower than 2x are not unusual. 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 Shanghai DragonNet TechnologyLtd

How Has Shanghai DragonNet TechnologyLtd Performed Recently?

As an illustration, revenue has deteriorated at Shanghai DragonNet TechnologyLtd over the last year, which is not ideal at all. 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.

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 Shanghai DragonNet TechnologyLtd's earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shanghai DragonNet TechnologyLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 26% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 21% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 20% shows it's an unpleasant look.

In light of this, it's alarming that Shanghai DragonNet TechnologyLtd's P/S sits above the majority of other companies. 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.

What We Can Learn From Shanghai DragonNet TechnologyLtd's P/S?

The strong share price surge has lead to Shanghai DragonNet TechnologyLtd's P/S soaring as well. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Shanghai DragonNet TechnologyLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. 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.

We don't want to rain on the parade too much, but we did also find 2 warning signs for Shanghai DragonNet TechnologyLtd that you need to be mindful of.

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.