Hengli Industrial Development Group Co., Ltd. (SZSE:000622) 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. But the last month did very little to improve the 56% share price decline over the last year.

Since its price has surged higher, you could be forgiven for thinking Hengli Industrial Development Group is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 6.6x, considering almost half the companies in China's Auto Components industry have P/S ratios below 2x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

How Has Hengli Industrial Development Group Performed Recently?

For example, consider that Hengli Industrial Development Group'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?

The only time you'd be truly comfortable seeing a P/S as steep as Hengli Industrial Development Group's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered a frustrating 41% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 73% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 25% shows it's an unpleasant look.

With this in mind, we find it worrying that Hengli Industrial Development Group's P/S exceeds that of its industry peers. 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.

What Does Hengli Industrial Development Group's P/S Mean For Investors?

The strong share price surge has lead to Hengli Industrial Development Group's P/S soaring as well. Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Hengli Industrial Development Group 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.

There are also other vital risk factors to consider before investing and we've discovered 3 warning signs for Hengli Industrial Development Group that you should be aware of.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.

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