What Chung Hwa Chemical Industrial Works, Ltd.'s (TWSE:1727) 28% Share Price Gain Is Not Telling You

Chung Hwa Chemical Industrial Works, Ltd. (TWSE:1727) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Looking further back, the 14% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Following the firm bounce in price, given close to half the companies operating in Taiwan's Chemicals industry have price-to-sales ratios (or "P/S") below 1.7x, you may consider Chung Hwa Chemical Industrial Works as a stock to potentially avoid with its 2.3x P/S ratio. 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.

Check out our latest analysis for Chung Hwa Chemical Industrial Works

How Chung Hwa Chemical Industrial Works Has Been Performing

For example, consider that Chung Hwa Chemical Industrial Works' financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. 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 Chung Hwa Chemical Industrial Works will help you shine a light on its historical performance.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Chung Hwa Chemical Industrial Works' to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 8.1%. Regardless, revenue has managed to lift by a handy 5.4% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable for the company.

This is in contrast to the rest of the industry, which is expected to grow by 8.8% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Chung Hwa Chemical Industrial Works' P/S sits above the majority of other companies. 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.

What We Can Learn From Chung Hwa Chemical Industrial Works' P/S?

The large bounce in Chung Hwa Chemical Industrial Works' shares has lifted the company's P/S handsomely. 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.

Our examination of Chung Hwa Chemical Industrial Works 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. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Chung Hwa Chemical Industrial Works (at least 1 which is a bit concerning), and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Chung Hwa Chemical Industrial Works, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.