Guan Chao Holdings Limited's (HKG:1872) 30% Price Boost Is Out Of Tune With Revenues

Guan Chao Holdings Limited (HKG:1872) shares have had a really impressive month, gaining 30% after a shaky period beforehand. The annual gain comes to 286% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, you could be forgiven for thinking Guan Chao Holdings is a stock not worth researching with a price-to-sales ratios (or "P/S") of 2.2x, considering almost half the companies in Hong Kong's Specialty Retail industry have P/S ratios below 0.5x. 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.

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Check out our latest analysis for Guan Chao Holdings

How Guan Chao Holdings Has Been Performing

Guan Chao Holdings certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. Perhaps the market is expecting future revenue performance to outperform the wider market, which has seemingly got people interested in the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Guan Chao Holdings?

In order to justify its P/S ratio, Guan Chao Holdings would need to produce impressive growth in excess of the industry.

Retrospectively, the last year delivered an exceptional 69% gain to the company's top line. Revenue has also lifted 18% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been respectable for the company.

Comparing that to the industry, which is predicted to deliver 42% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this information, we find it concerning that Guan Chao Holdings is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What Does Guan Chao Holdings' P/S Mean For Investors?

The large bounce in Guan Chao Holdings' shares has lifted the company's P/S handsomely. 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.

The fact that Guan Chao Holdings currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. 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.

Having said that, be aware Guan Chao Holdings is showing 3 warning signs in our investment analysis, and 2 of those are a bit unpleasant.

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.