Despite an already strong run, Xingyuan Environment Technology Co., Ltd. (SZSE:300266) shares have been powering on, with a gain of 26% in the last thirty days. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 49% over that time.

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 Xingyuan Environment Technology as a stock probably not worth researching with its 3.5x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Xingyuan Environment Technology Has Been Performing

For example, consider that Xingyuan Environment Technology'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. However, if this isn't the case, investors might get caught out paying too much for the stock.

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 high as Xingyuan Environment Technology's is when the company's growth is on track to outshine 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 32%. This means it has also seen a slide in revenue over the longer-term as revenue is down 74% 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.

In contrast to the company, the rest of the industry is expected to grow by 23% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Xingyuan Environment Technology's P/S exceeds that of its industry peers. 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Final Word

Xingyuan Environment Technology's P/S is on the rise since its shares have risen strongly. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our examination of Xingyuan Environment Technology revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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.

It is also worth noting that we have found 2 warning signs for Xingyuan Environment Technology (1 is a bit unpleasant!) that you need to take into consideration.

If you're unsure about the strength of Xingyuan Environment Technology's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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