Unfortunately for some shareholders, the Shanghai STEP Electric Corporation (SZSE:002527) share price has dived 31% in the last thirty days, prolonging recent pain. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 18% in that time.

After such a large drop in price, when close to half the companies operating in China's Machinery industry have price-to-sales ratios (or "P/S") above 2.3x, you may consider Shanghai STEP Electric as an enticing stock to check out with its 1.3x P/S ratio. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

What Does Shanghai STEP Electric's Recent Performance Look Like?

For example, consider that Shanghai STEP Electric's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the disappointing revenue performance to continue or accelerate, which has repressed the P/S. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

Do Revenue Forecasts Match The Low P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as low as Shanghai STEP Electric's is when the company's growth is on track to lag the industry.

Retrospectively, the last year delivered a frustrating 8.3% 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 13% 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 27% 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 are not surprised that Shanghai STEP Electric is trading at a P/S lower than the industry. Nonetheless, there's no guarantee the P/S has reached a floor yet with revenue going in reverse. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

The Key Takeaway

Shanghai STEP Electric's P/S has taken a dip along with its share price. 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.

As we suspected, our examination of Shanghai STEP Electric revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Given the current circumstances, it seems unlikely that the share price will experience any significant movement in either direction in the near future if recent medium-term revenue trends persist.

You should always think about risks. Case in point, we've spotted 1 warning sign for Shanghai STEP Electric you should be aware of.

If you're unsure about the strength of Shanghai STEP Electric's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.