Dongguan Huali Industries Co.,Ltd (SHSE:603038) shares have had a really impressive month, gaining 27% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 52%.

After such a large jump in price, when almost half of the companies in China's Consumer Durables industry have price-to-sales ratios (or "P/S") below 1.9x, you may consider Dongguan Huali IndustriesLtd as a stock probably not worth researching with its 3.4x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

What Does Dongguan Huali IndustriesLtd's P/S Mean For Shareholders?

For example, consider that Dongguan Huali IndustriesLtd's financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is high because investors think the company will still do 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.

What Are Revenue Growth Metrics Telling Us About The High P/S?

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 16%. The last three years don't look nice either as the company has shrunk revenue by 16% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 12% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Dongguan Huali IndustriesLtd's P/S sits above the majority of other companies. 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

What Does Dongguan Huali IndustriesLtd's P/S Mean For Investors?

Dongguan Huali IndustriesLtd shares have taken a big step in a northerly direction, but its P/S is elevated as a result. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Before you settle on your opinion, we've discovered 3 warning signs for Dongguan Huali IndustriesLtd (2 can't be ignored!) that you should be aware of.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.