What Wuxi Huadong Heavy Machinery Co., Ltd.'s (SZSE:002685) 36% Share Price Gain Is Not Telling You

Simply Wall St · 10/15 22:31

Wuxi Huadong Heavy Machinery Co., Ltd. (SZSE:002685) shares have continued their recent momentum with a 36% gain in the last month alone. Taking a wider view, although not as strong as the last month, the full year gain of 10% is also fairly reasonable.

Since its price has surged higher, you could be forgiven for thinking Wuxi Huadong Heavy Machinery is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 5.4x, considering almost half the companies in China's Machinery industry have P/S ratios below 2.6x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Wuxi Huadong Heavy Machinery

ps-multiple-vs-industry
SZSE:002685 Price to Sales Ratio vs Industry October 15th 2024

What Does Wuxi Huadong Heavy Machinery's Recent Performance Look Like?

For instance, Wuxi Huadong Heavy Machinery's receding revenue in recent times would have to be some food for thought. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Wuxi Huadong Heavy Machinery's earnings, revenue and cash flow.

Is There Enough Revenue Growth Forecasted For Wuxi Huadong Heavy Machinery?

The only time you'd be truly comfortable seeing a P/S as steep as Wuxi Huadong Heavy Machinery's is when the company's growth is on track to outshine the industry decidedly.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 33%. The last three years don't look nice either as the company has shrunk revenue by 90% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 23% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Wuxi Huadong Heavy Machinery 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 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 Wuxi Huadong Heavy Machinery's P/S Mean For Investors?

The strong share price surge has lead to Wuxi Huadong Heavy Machinery'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.

Our examination of Wuxi Huadong Heavy Machinery 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. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Having said that, be aware Wuxi Huadong Heavy Machinery is showing 2 warning signs in our investment analysis, and 1 of those is significant.

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.