Chengdu Information Technology of Chinese Academy of Sciences Co.,Ltd's (SZSE:300678) 37% Share Price Surge Not Quite Adding Up

Chengdu Information Technology of Chinese Academy of Sciences Co.,Ltd (SZSE:300678) shares have had a really impressive month, gaining 37% after a shaky period beforehand. The last month tops off a massive increase of 141% in the last year.

After such a large jump in price, you could be forgiven for thinking Chengdu Information Technology of Chinese Academy of SciencesLtd is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 19.2x, considering almost half the companies in China's IT industry have P/S ratios below 3.6x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Chengdu Information Technology of Chinese Academy of SciencesLtd

What Does Chengdu Information Technology of Chinese Academy of SciencesLtd's P/S Mean For Shareholders?

Revenue has risen at a steady rate over the last year for Chengdu Information Technology of Chinese Academy of SciencesLtd, which is generally not a bad outcome. Perhaps the market believes the recent revenue performance is strong enough to outperform the industry, which has inflated the P/S ratio. 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 Chengdu Information Technology of Chinese Academy of SciencesLtd, take a look at this free data-rich visualisation to see how the company stacks up on earnings, revenue and cash flow.

What Are Revenue Growth Metrics Telling Us About The High P/S?

In order to justify its P/S ratio, Chengdu Information Technology of Chinese Academy of SciencesLtd would need to produce outstanding growth that's well in excess of the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 5.8%. The solid recent performance means it was also able to grow revenue by 17% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 41% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

In light of this, it's alarming that Chengdu Information Technology of Chinese Academy of SciencesLtd'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 good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What Does Chengdu Information Technology of Chinese Academy of SciencesLtd's P/S Mean For Investors?

Chengdu Information Technology of Chinese Academy of SciencesLtd's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

The fact that Chengdu Information Technology of Chinese Academy of SciencesLtd currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Chengdu Information Technology of Chinese Academy of SciencesLtd, and understanding should be part of your investment process.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.