Shanghai Wisdom Information Technology Co., Ltd.'s (SZSE:301315) 26% Share Price Surge Not Quite Adding Up

Shanghai Wisdom Information Technology Co., Ltd. (SZSE:301315) shares have had a really impressive month, gaining 26% after a shaky period beforehand. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Since its price has surged higher, given around half the companies in China's IT industry have price-to-sales ratios (or "P/S") below 3.4x, you may consider Shanghai Wisdom Information Technology as a stock to avoid entirely with its 17.9x 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 Wisdom Information Technology

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

The revenue growth achieved at Shanghai Wisdom Information Technology over the last year would be more than acceptable for most companies. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on Shanghai Wisdom Information Technology will help you shine a light on its historical performance.

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

In order to justify its P/S ratio, Shanghai Wisdom Information Technology 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 terrific increase of 20%. The latest three year period has also seen a 29% overall rise in revenue, aided extensively by its short-term performance. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

This is in contrast to the rest of the industry, which is expected to grow by 41% 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 Shanghai Wisdom Information Technology'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. 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 Bottom Line On Shanghai Wisdom Information Technology's P/S

The strong share price surge has lead to Shanghai Wisdom Information Technology's P/S soaring as well. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

The fact that Shanghai Wisdom Information Technology 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. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely 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.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Shanghai Wisdom Information Technology that you need to be mindful of.

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.