Weihai Huadong Automation Co., Ltd (SZSE:002248) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 17% in the last twelve months.

Following the firm bounce in price, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.4x, you may consider Weihai Huadong Automation as a stock not worth researching with its 7.4x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Weihai Huadong Automation's Recent Performance Look Like?

We'd have to say that with no tangible growth over the last year, Weihai Huadong Automation's revenue has been unimpressive. One possibility is that the P/S is high because investors think the benign revenue growth will improve to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Weihai Huadong Automation's Revenue Growth Trending?

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

Retrospectively, the last year delivered virtually the same number to the company's top line as the year before. Still, the latest three year period has seen an excellent 37% overall rise in revenue, in spite of its uninspiring short-term performance. Therefore, it's fair to say the revenue growth recently has been great for the company, but investors will want to ask why it has slowed to such an extent.

Comparing that to the industry, which is predicted to deliver 22% 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 alarming that Weihai Huadong Automation's P/S sits above the majority of other companies. 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 good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Key Takeaway

The strong share price surge has lead to Weihai Huadong Automation'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.

Our examination of Weihai Huadong Automation revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Weihai Huadong Automation (at least 1 which can't be ignored), and understanding them should be part of your investment process.

If these risks are making you reconsider your opinion on Weihai Huadong Automation, 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.