Shenzhen Tongyi Industry Co., Ltd. (SZSE:300538) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Even after such a large jump in price, there still wouldn't be many who think Shenzhen Tongyi Industry's price-to-sales (or "P/S") ratio of 1x is worth a mention when the median P/S in China's Trade Distributors industry is similar at about 0.6x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

What Does Shenzhen Tongyi Industry's Recent Performance Look Like?

Revenue has risen firmly for Shenzhen Tongyi Industry recently, which is pleasing to see. Perhaps the market is expecting future revenue performance to only keep up with the broader industry, which has keeping the P/S in line with expectations. Those who are bullish on Shenzhen Tongyi Industry will be hoping that this isn't the case, so that they can pick up the stock at a lower valuation.

Do Revenue Forecasts Match The P/S Ratio?

Shenzhen Tongyi Industry's P/S ratio would be typical for a company that's only expected to deliver moderate growth, and importantly, perform in line with the industry.

Retrospectively, the last year delivered an exceptional 19% gain to the company's top line. The strong recent performance means it was also able to grow revenue by 44% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 20% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

In light of this, it's curious that Shenzhen Tongyi Industry's P/S sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as a continuation of recent revenue trends is likely to weigh down the shares eventually.

What We Can Learn From Shenzhen Tongyi Industry's P/S?

Shenzhen Tongyi Industry's stock has a lot of momentum behind it lately, which has brought its P/S level with the rest of the industry. 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.

We've established that Shenzhen Tongyi Industry's average P/S is a bit surprising since its recent three-year growth is lower than the wider industry forecast. When we see weak revenue with slower than industry growth, we suspect the share price is at risk of declining, bringing the P/S back in line with expectations. If recent medium-term revenue trends continue, the probability of a share price decline will become quite substantial, placing shareholders at risk.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Shenzhen Tongyi Industry, and understanding these should be part of your investment process.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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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