Anhui Tuoshan Heavy Industry Co., Ltd. (SZSE:001226) shareholders are no doubt pleased to see that the share price has bounced 27% in the last month, although it is still struggling to make up recently lost ground. Taking a wider view, although not as strong as the last month, the full year gain of 20% is also fairly reasonable.

After such a large jump in price, 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 Anhui Tuoshan Heavy Industry as a stock not worth researching with its 4.9x 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 Anhui Tuoshan Heavy Industry's P/S Mean For Shareholders?

For instance, Anhui Tuoshan Heavy Industry's receding revenue in recent times would have to be some food for thought. 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.

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

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Anhui Tuoshan Heavy Industry's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 29% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 28% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

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 in mind, we find it worrying that Anhui Tuoshan Heavy Industry's P/S exceeds that of its industry peers. 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 We Can Learn From Anhui Tuoshan Heavy Industry's P/S?

Anhui Tuoshan Heavy Industry's P/S has grown nicely over the last month thanks to a handy boost in the share price. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that Anhui Tuoshan Heavy Industry 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. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Plus, you should also learn about these 5 warning signs we've spotted with Anhui Tuoshan Heavy Industry (including 3 which can't be ignored).

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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