Investor Optimism Abounds China Youzan Limited (HKG:8083) But Growth Is Lacking

When close to half the companies in the Software industry in Hong Kong have price-to-sales ratios (or "P/S") below 1.2x, you may consider China Youzan Limited (HKG:8083) as a stock to potentially avoid with its 1.8x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

See our latest analysis for China Youzan

What Does China Youzan's P/S Mean For Shareholders?

China Youzan could be doing better as its revenue has been going backwards lately while most other companies have been seeing positive revenue growth. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. However, if this isn't the case, investors might get caught out paying too much for the stock.

If you'd like to see what analysts are forecasting going forward, you should check out our free report on China Youzan.

How Is China Youzan's Revenue Growth Trending?

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

Retrospectively, the last year delivered virtually the same number to the company's top line as the year before. Whilst it's an improvement, it wasn't enough to get the company out of the hole it was in, with revenue down 12% overall from three years ago. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Turning to the outlook, the next year should generate growth of 0.2% as estimated by the two analysts watching the company. With the industry predicted to deliver 23% growth, the company is positioned for a weaker revenue result.

In light of this, it's alarming that China Youzan's P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Final Word

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.

It comes as a surprise to see China Youzan trade at such a high P/S given the revenue forecasts look less than stellar. Right now we aren't comfortable with the high P/S as the predicted future revenues aren't likely to support such positive sentiment for long. This places 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 China Youzan (at least 1 which is significant), and understanding them should be part of your investment process.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.