What China Wacan Group Company Limited's (HKG:1920) 28% Share Price Gain Is Not Telling You

China Wacan Group Company Limited (HKG:1920) shareholders are no doubt pleased to see that the share price has bounced 28% in the last month, although it is still struggling to make up recently lost ground. Looking back a bit further, it's encouraging to see the stock is up 45% in the last year.

Since its price has surged higher, when almost half of the companies in Hong Kong's Consumer Durables industry have price-to-sales ratios (or "P/S") below 0.5x, you may consider China Wacan Group as a stock not worth researching with its 3.2x 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.

See our latest analysis for China Wacan Group

How China Wacan Group Has Been Performing

As an illustration, revenue has deteriorated at China Wacan Group over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is China Wacan Group's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like China Wacan Group's 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 30%. The last three years don't look nice either as the company has shrunk revenue by 48% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 12% shows it's an unpleasant look.

In light of this, it's alarming that China Wacan Group's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Key Takeaway

The strong share price surge has lead to China Wacan Group's P/S soaring as well. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that China Wacan Group currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

You should always think about risks. Case in point, we've spotted 4 warning signs for China Wacan Group you should be aware of, and 2 of them shouldn't be ignored.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.