When close to half the companies in the Luxury industry in China have price-to-sales ratios (or "P/S") below 1.7x, you may consider DR Corporation Limited (SZSE:301177) as a stock to avoid entirely with its 5.3x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How DR Has Been Performing

While the industry has experienced revenue growth lately, DR's revenue has gone into reverse gear, which is not great. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

How Is DR's Revenue Growth Trending?

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

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 40%. 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.

Shifting to the future, estimates from the three analysts covering the company suggest revenue should grow by 18% over the next year. That's shaping up to be similar to the 18% growth forecast for the broader industry.

With this information, we find it interesting that DR 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 Final Word

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.

Analysts are forecasting DR's revenues to only grow on par with the rest of the industry, which has lead to the high P/S ratio being unexpected. The fact that the revenue figures aren't setting the world alight has us doubtful that the company's elevated P/S can be sustainable for the long term. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 1 warning sign for DR that you need to take into consideration.

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.