More Unpleasant Surprises Could Be In Store For Capitalonline Data Service Co., Ltd.'s (SZSE:300846) Shares After Tumbling 28%

The Capitalonline Data Service Co., Ltd. (SZSE:300846) share price has softened a substantial 28% over the previous 30 days, handing back much of the gains the stock has made lately. Still, a bad month hasn't completely ruined the past year with the stock gaining 81%, which is great even in a bull market.

In spite of the heavy fall in price, Capitalonline Data Service's price-to-sales (or "P/S") ratio of 7.9x might still make it look like a sell right now compared to the wider IT industry in China, where around half of the companies have P/S ratios below 5.7x and even P/S below 2x are quite common. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

Check out our latest analysis for Capitalonline Data Service

What Does Capitalonline Data Service's P/S Mean For Shareholders?

The revenue growth achieved at Capitalonline Data Service over the last year would be more than acceptable for most companies. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

Although there are no analyst estimates available for Capitalonline Data Service, 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?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Capitalonline Data Service's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 21% gain to the company's top line. As a result, it also grew revenue by 22% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been respectable for the company.

This is in contrast to the rest of the industry, which is expected to grow by 18% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this in mind, we find it worrying that Capitalonline Data Service's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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.

The Final Word

Despite the recent share price weakness, Capitalonline Data Service's P/S remains higher than most other companies in the industry. 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.

Our examination of Capitalonline Data Service revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

Having said that, be aware Capitalonline Data Service is showing 2 warning signs in our investment analysis, you should know about.

If these risks are making you reconsider your opinion on Capitalonline Data Service, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.