When close to half the companies in the Machinery industry in China have price-to-sales ratios (or "P/S") below 3.1x, you may consider RongFa Nuclear Equipment Co., Ltd. (SZSE:002366) as a stock to avoid entirely with its 18.6x 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.

See our latest analysis for RongFa Nuclear Equipment

What Does RongFa Nuclear Equipment's P/S Mean For Shareholders?

RongFa Nuclear Equipment certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. The P/S ratio is probably high because investors think this strong revenue growth will be enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

RongFa Nuclear Equipment's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Retrospectively, the last year delivered an exceptional 54% gain to the company's top line. Revenue has also lifted 24% 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 the recent medium-term revenue trends against the industry's one-year growth forecast of 31% shows it's noticeably less attractive.

With this information, we find it concerning that RongFa Nuclear Equipment is trading at a P/S higher than the industry. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 RongFa Nuclear Equipment's P/S Mean For Investors?

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 RongFa Nuclear Equipment revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You should always think about risks. Case in point, we've spotted 2 warning signs for RongFa Nuclear Equipment you should be aware of.

If these risks are making you reconsider your opinion on RongFa Nuclear Equipment, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.