Thinker Agricultural Machinery Co., Ltd. (SHSE:603789) shares have had a horrible month, losing 30% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 23% share price drop.

In spite of the heavy fall in price, given around half the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.5x, you may still consider Thinker Agricultural Machinery as a stock to avoid entirely with its 11.4x 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.

How Has Thinker Agricultural Machinery Performed Recently?

As an illustration, revenue has deteriorated at Thinker Agricultural Machinery 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Thinker Agricultural Machinery's Revenue Growth Trending?

In order to justify its P/S ratio, Thinker Agricultural Machinery 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 36%. The last three years don't look nice either as the company has shrunk revenue by 56% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 28% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Thinker Agricultural Machinery's P/S exceeds that of its industry peers. 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

Even after such a strong price drop, Thinker Agricultural Machinery's P/S still exceeds the industry median significantly. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Thinker Agricultural Machinery currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. 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.

Before you take the next step, you should know about the 3 warning signs for Thinker Agricultural Machinery that we have uncovered.

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.