When you see that almost half of the companies in the Software industry in China have price-to-sales ratios (or "P/S") below 6.5x, Transwarp Technology (Shanghai) Co.,Ltd. (SHSE:688031) looks to be giving off some sell signals with its 9x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

How Transwarp Technology (Shanghai)Ltd Has Been Performing

Transwarp Technology (Shanghai)Ltd certainly has been doing a good job lately as it's been growing revenue more than most other companies. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For Transwarp Technology (Shanghai)Ltd?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Transwarp Technology (Shanghai)Ltd's to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 13%. Pleasingly, revenue has also lifted 44% in aggregate from three years ago, partly thanks to the last 12 months of growth. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Turning to the outlook, the next year should generate growth of 79% as estimated by the two analysts watching the company. With the industry only predicted to deliver 33%, the company is positioned for a stronger revenue result.

With this information, we can see why Transwarp Technology (Shanghai)Ltd is trading at such a high P/S compared to the industry. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Final Word

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 Transwarp Technology (Shanghai)Ltd maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the Software industry, as expected. At this stage investors feel the potential for a deterioration in revenues is quite remote, justifying the elevated P/S ratio. It's hard to see the share price falling strongly in the near future under these circumstances.

You need to take note of risks, for example - Transwarp Technology (Shanghai)Ltd has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

If these risks are making you reconsider your opinion on Transwarp Technology (Shanghai)Ltd, 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.