Revenues Not Telling The Story For Hengfeng Information Technology Co., Ltd. (SZSE:300605) After Shares Rise 25%

Hengfeng Information Technology Co., Ltd. (SZSE:300605) shareholders have had their patience rewarded with a 25% share price jump in the last month. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 21% over that time.

Following the firm bounce in price, you could be forgiven for thinking Hengfeng Information Technology is a stock not worth researching with a price-to-sales ratios (or "P/S") of 5.4x, considering almost half the companies in China's IT industry have P/S ratios below 3.7x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

View our latest analysis for Hengfeng Information Technology

What Does Hengfeng Information Technology's P/S Mean For Shareholders?

For example, consider that Hengfeng Information Technology's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

Although there are no analyst estimates available for Hengfeng Information Technology, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Hengfeng Information Technology would need to produce impressive growth in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 36%. This means it has also seen a slide in revenue over the longer-term as revenue is down 36% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 20% 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 Hengfeng Information Technology 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. 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 Does Hengfeng Information Technology's P/S Mean For Investors?

Hengfeng Information Technology shares have taken a big step in a northerly direction, but its P/S is elevated as a result. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Hengfeng Information Technology 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.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Hengfeng Information Technology you should know about.

If you're unsure about the strength of Hengfeng Information Technology's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.