What China New Energy Limited's (HKG:1156) 33% Share Price Gain Is Not Telling You

China New Energy Limited (HKG:1156) shareholders would be excited to see that the share price has had a great month, posting a 33% gain and recovering from prior weakness. Notwithstanding the latest gain, the annual share price return of 2.7% isn't as impressive.

Even after such a large jump in price, it's still not a stretch to say that China New Energy's price-to-sales (or "P/S") ratio of 0.7x right now seems quite "middle-of-the-road" compared to the Construction industry in Hong Kong, where the median P/S ratio is around 0.3x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

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See our latest analysis for China New Energy

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

With revenue growth that's exceedingly strong of late, China New Energy has been doing very well. Perhaps the market is expecting future revenue performance to taper off, which has kept the P/S from rising. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's not quite in favour.

Is There Some Revenue Growth Forecasted For China New Energy?

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

Taking a look back first, we see that the company grew revenue by an impressive 104% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 78% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 16% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that China New Energy's P/S exceeds that of its industry peers. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh on the share price eventually.

The Key Takeaway

Its shares have lifted substantially and now China New Energy's P/S is back within range of the industry median. 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.

We find it unexpected that China New Energy trades at a P/S ratio that is comparable to the rest of the industry, despite experiencing declining revenues during the medium-term, while the industry as a whole is expected to grow. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Having said that, be aware China New Energy is showing 3 warning signs in our investment analysis, 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.