There's Reason For Concern Over Shanghai DragonNet Technology Co.,Ltd.'s (SZSE:300245) Massive 63% Price Jump

The Shanghai DragonNet Technology Co.,Ltd. (SZSE:300245) share price has done very well over the last month, posting an excellent gain of 63%. Notwithstanding the latest gain, the annual share price return of 5.4% isn't as impressive.

Since its price has surged higher, when almost half of the companies in China's IT industry have price-to-sales ratios (or "P/S") below 3.8x, you may consider Shanghai DragonNet TechnologyLtd as a stock not worth researching with its 6.9x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

See our latest analysis for Shanghai DragonNet TechnologyLtd

How Shanghai DragonNet TechnologyLtd Has Been Performing

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.

Although there are no analyst estimates available for Shanghai DragonNet 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 Shanghai DragonNet TechnologyLtd's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as steep as Shanghai DragonNet TechnologyLtd's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered a frustrating 32% 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 19% 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. 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

Shares in Shanghai DragonNet TechnologyLtd have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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 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. 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Shanghai DragonNet TechnologyLtd that you should be aware 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.