Why Investors Shouldn't Be Surprised By China Zenith Chemical Group Limited's (HKG:362) 27% Share Price Plunge

To the annoyance of some shareholders, China Zenith Chemical Group Limited (HKG:362) shares are down a considerable 27% in the last month, which continues a horrid run for the company. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 49% share price drop.

Following the heavy fall in price, China Zenith Chemical Group's price-to-sales (or "P/S") ratio of 0.5x might make it look like a strong buy right now compared to the wider Electric Utilities industry in Hong Kong, where around half of the companies have P/S ratios above 2.7x and even P/S above 12x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly reduced P/S.

View our latest analysis for China Zenith Chemical Group

How China Zenith Chemical Group Has Been Performing

For instance, China Zenith Chemical Group's receding revenue in recent times would have to be some food for thought. It might be that many expect the disappointing revenue performance to continue or accelerate, which has repressed the P/S. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

Want the full picture on earnings, revenue and cash flow for the company? Then our free report on China Zenith Chemical Group will help you shine a light on its historical performance.

Do Revenue Forecasts Match The Low P/S Ratio?

China Zenith Chemical Group's P/S ratio would be typical for a company that's expected to deliver very poor growth or even falling revenue, and importantly, perform much worse than the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 73%. As a result, revenue from three years ago have also fallen 48% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 0.05% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we are not surprised that China Zenith Chemical Group is trading at a P/S lower than the industry. Nonetheless, there's no guarantee the P/S has reached a floor yet with revenue going in reverse. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

The Final Word

Having almost fallen off a cliff, China Zenith Chemical Group's share price has pulled its P/S way down as well. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

As we suspected, our examination of China Zenith Chemical Group revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

Don't forget that there may be other risks. For instance, we've identified 5 warning signs for China Zenith Chemical Group that you should be aware of.

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.