Qinghai Huading Industrial Co., Ltd. (SHSE:600243) shareholders are no doubt pleased to see that the share price has bounced 28% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 23% over that time.

Following the firm bounce in price, you could be forgiven for thinking Qinghai Huading Industrial is a stock not worth researching with a price-to-sales ratios (or "P/S") of 4.1x, considering almost half the companies in China's Machinery industry have P/S ratios below 2.4x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's as high as it is.

How Has Qinghai Huading Industrial Performed Recently?

For example, consider that Qinghai Huading Industrial'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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Qinghai Huading Industrial would need to produce impressive growth in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 25%. The last three years don't look nice either as the company has shrunk revenue by 47% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 22% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Qinghai Huading Industrial is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Bottom Line On Qinghai Huading Industrial's P/S

The large bounce in Qinghai Huading Industrial's shares has lifted the company's P/S handsomely. 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 established that Qinghai Huading Industrial currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Qinghai Huading Industrial 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.