Why Investors Shouldn't Be Surprised By ZONQING Environmental Limited's (HKG:1855) 26% Share Price Surge

ZONQING Environmental Limited (HKG:1855) shares have continued their recent momentum with a 26% gain in the last month alone. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 6.1% in the last twelve months.

After such a large jump in price, given around half the companies in Hong Kong's Commercial Services industry have price-to-sales ratios (or "P/S") below 0.5x, you may consider ZONQING Environmental as a stock to avoid entirely with its 4x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

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View our latest analysis for ZONQING Environmental

What Does ZONQING Environmental's Recent Performance Look Like?

For instance, ZONQING Environmental's receding revenue in recent times would have to be some food for thought. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 ZONQING Environmental's earnings, revenue and cash flow.

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

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

Retrospectively, the last year delivered a frustrating 26% decrease to the company's top line. Even so, admirably revenue has lifted 86% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing revenue over that time, even though it had some hiccups along the way.

Comparing that recent medium-term revenue trajectory with the industry's one-year growth forecast of 5.5% shows it's noticeably more attractive.

With this in consideration, it's not hard to understand why ZONQING Environmental's P/S is high relative to its industry peers. Presumably shareholders aren't keen to offload something they believe will continue to outmanoeuvre the wider industry.

What We Can Learn From ZONQING Environmental's P/S?

The strong share price surge has lead to ZONQING Environmental's P/S soaring as well. 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 ZONQING Environmental maintains its high P/S on the strength of its recent three-year growth being higher than the wider industry forecast, as expected. Right now shareholders are comfortable with the P/S as they are quite confident revenue aren't under threat. Barring any significant changes to the company's ability to make money, the share price should continue to be propped up.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with ZONQING Environmental (at least 1 which can't be ignored), and understanding these 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.