You may think that with a price-to-sales (or "P/S") ratio of 3.4x New Guomai Digital Culture Co., Ltd. (SHSE:600640) is a stock worth checking out, seeing as almost half of all the Interactive Media and Services companies in China have P/S ratios greater than 5.2x and even P/S higher than 10x aren't out of the ordinary. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

What Does New Guomai Digital Culture's P/S Mean For Shareholders?

For example, consider that New Guomai Digital Culture's financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is low because investors think the company won't do enough to avoid underperforming the broader industry in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

How Is New Guomai Digital Culture's Revenue Growth Trending?

In order to justify its P/S ratio, New Guomai Digital Culture would need to produce sluggish growth that's trailing the industry.

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 23%. The last three years don't look nice either as the company has shrunk revenue by 50% in aggregate. 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 10% shows it's an unpleasant look.

With this information, we are not surprised that New Guomai Digital Culture is trading at a P/S lower than the industry. Nonetheless, there's no guarantee the P/S has reached a floor yet with revenue going in reverse. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

The Final Word

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.

It's no surprise that New Guomai Digital Culture maintains its low P/S off the back of its sliding revenue over the medium-term. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Given the current circumstances, it seems unlikely that the share price will experience any significant movement in either direction in the near future if recent medium-term revenue trends persist.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with New Guomai Digital Culture, and understanding should be part of your investment process.

If these risks are making you reconsider your opinion on New Guomai Digital Culture, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

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