To the annoyance of some shareholders, Zotye Automobile Co., Ltd (SZSE:000980) shares are down a considerable 25% in the last month, which continues a horrid run for the company. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 32% in that time.

Although its price has dipped substantially, when almost half of the companies in China's Auto industry have price-to-sales ratios (or "P/S") below 1.9x, you may still consider Zotye Automobile as a stock not worth researching with its 11.8x 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 Zotye Automobile Has Been Performing

For example, consider that Zotye Automobile'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.

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

Zotye Automobile'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 17%. This means it has also seen a slide in revenue over the longer-term as revenue is down 49% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 53% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Zotye Automobile is trading at a P/S higher than the industry. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Final Word

A significant share price dive has done very little to deflate Zotye Automobile's very lofty P/S. 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 Zotye Automobile currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

A lot of potential risks can sit within a company's balance sheet. Our free balance sheet analysis for Zotye Automobile with six simple checks will allow you to discover any risks that could be an issue.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.