Dalian Zhiyun Automation Co., Ltd. (SZSE:300097) shares have had a really impressive month, gaining 33% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 58% in the last year.

Since its price has surged higher, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.8x, you may consider Dalian Zhiyun Automation as a stock not worth researching with its 5.8x 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.

What Does Dalian Zhiyun Automation's P/S Mean For Shareholders?

For example, consider that Dalian Zhiyun Automation'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as Dalian Zhiyun Automation's is when the company's growth is on track to outshine the industry decidedly.

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 16%. The last three years don't look nice either as the company has shrunk revenue by 39% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 27% shows it's an unpleasant look.

With this in mind, we find it worrying that Dalian Zhiyun Automation'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. 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.

The Final Word

Shares in Dalian Zhiyun Automation have seen a strong upwards swing lately, which has really helped boost its P/S figure. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Dalian Zhiyun Automation revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Dalian Zhiyun Automation (of which 1 doesn't sit too well with us!) you should know about.

If you're unsure about the strength of Dalian Zhiyun Automation'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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