Despite an already strong run, Dongguan Huali Industries Co.,Ltd (SHSE:603038) shares have been powering on, with a gain of 33% in the last thirty days. The annual gain comes to 111% following the latest surge, making investors sit up and take notice.

Following the firm bounce in price, when almost half of the companies in China's Consumer Durables industry have price-to-sales ratios (or "P/S") below 2x, you may consider Dongguan Huali IndustriesLtd as a stock not worth researching with its 4.4x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for Dongguan Huali IndustriesLtd

How Has Dongguan Huali IndustriesLtd Performed Recently?

As an illustration, revenue has deteriorated at Dongguan Huali IndustriesLtd over the last year, which is not ideal at all. 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.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Dongguan Huali IndustriesLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 16% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 16% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 13% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Dongguan Huali IndustriesLtd 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 Bottom Line On Dongguan Huali IndustriesLtd's P/S

The strong share price surge has lead to Dongguan Huali IndustriesLtd's P/S soaring as well. 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.

We've established that Dongguan Huali IndustriesLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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 the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

It is also worth noting that we have found 3 warning signs for Dongguan Huali IndustriesLtd (1 shouldn't be ignored!) that you need to take into consideration.

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).

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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.