You may think that with a price-to-sales (or "P/S") ratio of 14.2x Shenzhen iN-Cube Automation Co., Ltd. (SZSE:301312) is a stock to avoid completely, seeing as almost half of all the Electronic companies in China have P/S ratios under 4.3x and even P/S lower than 2x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

View our latest analysis for Shenzhen iN-Cube Automation

How Shenzhen iN-Cube Automation Has Been Performing

For example, consider that Shenzhen iN-Cube Automation's financial performance has been poor lately as its revenue has been in decline. 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For Shenzhen iN-Cube Automation?

In order to justify its P/S ratio, Shenzhen iN-Cube Automation would need to produce outstanding growth that's well in excess of the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 5.5%. That put a dampener on the good run it was having over the longer-term as its three-year revenue growth is still a noteworthy 28% in total. So we can start by confirming that the company has generally done a good job of growing revenue over that time, even though it had some hiccups along the way.

Comparing that to the industry, which is predicted to deliver 63% 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 Shenzhen iN-Cube Automation 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.

The Key Takeaway

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Shenzhen iN-Cube Automation 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. 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.

Plus, you should also learn about these 3 warning signs we've spotted with Shenzhen iN-Cube Automation (including 1 which is a bit concerning).

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.