QingHai HuaDing Industrial CO.,LTD. (SHSE:600243) shareholders would be excited to see that the share price has had a great month, posting a 28% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 37%.

Following the firm bounce in price, you could be forgiven for thinking QingHai HuaDing IndustrialLTD 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 3.3x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

Check out our latest analysis for QingHai HuaDing IndustrialLTD

What Does QingHai HuaDing IndustrialLTD's Recent Performance Look Like?

For instance, QingHai HuaDing IndustrialLTD'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. 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?

In order to justify its P/S ratio, QingHai HuaDing IndustrialLTD would need to produce outstanding growth that's well in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 35%. As a result, revenue from three years ago have also fallen 35% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 31% 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 QingHai HuaDing IndustrialLTD 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.

The Final Word

Shares in QingHai HuaDing IndustrialLTD have seen a strong upwards swing lately, which has really helped boost its P/S figure. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our examination of QingHai HuaDing IndustrialLTD 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. 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for QingHai HuaDing IndustrialLTD with six simple checks will allow you to discover any risks that could be an issue.

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.