Shenzhen Zhongheng Huafa Co., Ltd.'s (SZSE:000020) Popularity With Investors Under Threat As Stock Sinks 28%

Shenzhen Zhongheng Huafa Co., Ltd. (SZSE:000020) shareholders that were waiting for something to happen have been dealt a blow with a 28% share price drop in the last month. Looking back over the past twelve months the stock has been a solid performer regardless, with a gain of 18%.

In spite of the heavy fall in price, you could still be forgiven for thinking Shenzhen Zhongheng Huafa 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 Electronic industry have P/S ratios below 3.4x. 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.

See our latest analysis for Shenzhen Zhongheng Huafa

How Has Shenzhen Zhongheng Huafa Performed Recently?

Revenue has risen firmly for Shenzhen Zhongheng Huafa recently, which is pleasing to see. 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.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Shenzhen Zhongheng Huafa's earnings, revenue and cash flow.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as high as Shenzhen Zhongheng Huafa's is when the company's growth is on track to outshine the industry.

Taking a look back first, we see that the company managed to grow revenues by a handy 10% last year. Revenue has also lifted 11% in aggregate from three years ago, partly thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been respectable for the company.

Comparing that to the industry, which is predicted to deliver 23% 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 Shenzhen Zhongheng Huafa'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.

The Final Word

Shenzhen Zhongheng Huafa's P/S remain high even after its stock plunged. 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 Shenzhen Zhongheng Huafa 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 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. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shenzhen Zhongheng Huafa (at least 1 which makes us a bit uncomfortable), and understanding them 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.