There's Reason For Concern Over Hengfeng Information Technology Co., Ltd.'s (SZSE:300605) Massive 30% Price Jump

Hengfeng Information Technology Co., Ltd. (SZSE:300605) shareholders would be excited to see that the share price has had a great month, posting a 30% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 25% in the last twelve months.

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 4.2x, considering almost half the companies in China's IT industry have P/S ratios below 3.3x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for Hengfeng Information Technology

What Does Hengfeng Information Technology's Recent Performance Look Like?

For example, consider that Hengfeng Information Technology's financial performance has been poor lately as its revenue has been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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.

Retrospectively, the last year delivered a frustrating 16% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 14% in aggregate. 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 27% shows it's an unpleasant look.

With this in mind, we find it worrying that Hengfeng Information Technology'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

The large bounce in Hengfeng Information Technology's shares has lifted the company's P/S handsomely. 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 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. 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.

Before you take the next step, you should know about the 5 warning signs for Hengfeng Information Technology (3 are concerning!) that we have uncovered.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.

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