SG Micro Corp (SZSE:300661) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 17% over that time.

Following the firm bounce in price, SG Micro may be sending very bearish signals at the moment with a price-to-sales (or "P/S") ratio of 13x, since almost half of all companies in the Semiconductor industry in China have P/S ratios under 5.9x and even P/S lower than 2x are not unusual. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Has SG Micro Performed Recently?

While the industry has experienced revenue growth lately, SG Micro's revenue has gone into reverse gear, which is not great. Perhaps the market is expecting the poor revenue to reverse, justifying it's current high P/S.. 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 far outperform the industry for P/S ratios like SG Micro'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 3.2%. However, a few very strong years before that means that it was still able to grow revenue by an impressive 103% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would definitely welcome the medium-term rates of revenue growth.

Turning to the outlook, the next year should generate growth of 23% as estimated by the analysts watching the company. Meanwhile, the rest of the industry is forecast to expand by 36%, which is noticeably more attractive.

With this in consideration, we believe it doesn't make sense that SG Micro's P/S is outpacing its industry peers. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

The Final Word

The strong share price surge has lead to SG Micro's P/S soaring as well. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've concluded that SG Micro currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for SG Micro that you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.