Sheng Tang Holdings Limited (HKG:8305) May Have Run Too Fast Too Soon With Recent 27% Price Plummet

Sheng Tang Holdings Limited (HKG:8305) shares have retraced a considerable 27% in the last month, reversing a fair amount of their solid recent performance. Nonetheless, the last 30 days have barely left a scratch on the stock's annual performance, which is up a whopping 375%.

Even after such a large drop in price, given around half the companies in Hong Kong's Construction industry have price-to-sales ratios (or "P/S") below 0.3x, you may still consider Sheng Tang Holdings as a stock to avoid entirely with its 2.4x 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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See our latest analysis for Sheng Tang Holdings

How Has Sheng Tang Holdings Performed Recently?

Sheng Tang Holdings has been doing a decent job lately as it's been growing revenue at a reasonable pace. It might be that many expect the reasonable revenue performance to beat most other companies over the coming period, which has increased investors’ willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 Sheng Tang Holdings' to be considered reasonable.

Retrospectively, the last year delivered a decent 4.6% gain to the company's revenues. Still, lamentably revenue has fallen 2.7% in aggregate from three years ago, which is disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 6.6% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Sheng Tang Holdings is trading at a P/S higher than the industry. 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.

What Does Sheng Tang Holdings' P/S Mean For Investors?

Sheng Tang Holdings' shares may have suffered, but its P/S remains high. 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.

Our examination of Sheng Tang Holdings revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

And what about other risks? Every company has them, and we've spotted 4 warning signs for Sheng Tang Holdings (of which 2 are potentially serious!) you should know about.

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.