Merit Interactive Co.,Ltd. (SZSE:300766) shareholders that were waiting for something to happen have been dealt a blow with a 27% share price drop in the last month. The recent drop completes a disastrous twelve months for shareholders, who are sitting on a 55% loss during that time.

Although its price has dipped substantially, when almost half of the companies in China's IT industry have price-to-sales ratios (or "P/S") below 3.2x, you may still consider Merit InteractiveLtd as a stock not worth researching with its 8.8x 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 Merit InteractiveLtd's Recent Performance Look Like?

While the industry has experienced revenue growth lately, Merit InteractiveLtd's revenue has gone into reverse gear, which is not great. It might be that many expect the dour revenue performance to recover substantially, which has kept the P/S from collapsing. 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?

Merit InteractiveLtd's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 20%. This means it has also seen a slide in revenue over the longer-term as revenue is down 10% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Looking ahead now, revenue is anticipated to climb by 40% during the coming year according to the sole analyst following the company. Meanwhile, the rest of the industry is forecast to expand by 40%, which is not materially different.

With this information, we find it interesting that Merit InteractiveLtd is trading at a high P/S compared to the industry. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/S falls to levels more in line with the growth outlook.

The Bottom Line On Merit InteractiveLtd's P/S

Even after such a strong price drop, Merit InteractiveLtd's P/S still exceeds the industry median significantly. 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.

Seeing as its revenues are forecast to grow in line with the wider industry, it would appear that Merit InteractiveLtd currently trades on a higher than expected P/S. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

There are also other vital risk factors to consider and we've discovered 3 warning signs for Merit InteractiveLtd (1 shouldn't be ignored!) that you should be aware of before investing here.

If these risks are making you reconsider your opinion on Merit InteractiveLtd, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.