Zhejiang East Crystal Electronic Co.,Ltd. (SZSE:002199) shares have continued their recent momentum with a 31% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 34% in the last year.

Since its price has surged higher, Zhejiang East Crystal ElectronicLtd may be sending very bearish signals at the moment with a price-to-sales (or "P/S") ratio of 14x, since almost half of all companies in the Electronic industry in China have P/S ratios under 4.3x and even P/S lower than 2x are not unusual. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Has Zhejiang East Crystal ElectronicLtd Performed Recently?

The revenue growth achieved at Zhejiang East Crystal ElectronicLtd over the last year would be more than acceptable for most companies. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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 steep as Zhejiang East Crystal ElectronicLtd's is when the company's growth is on track to outshine the industry decidedly.

Taking a look back first, we see that the company grew revenue by an impressive 23% last year. However, this wasn't enough as the latest three year period has seen the company endure a nasty 35% drop in revenue in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Comparing that to the industry, which is predicted to deliver 27% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that Zhejiang East Crystal ElectronicLtd's P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Key Takeaway

The strong share price surge has lead to Zhejiang East Crystal ElectronicLtd's P/S soaring as well. 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 Zhejiang East Crystal ElectronicLtd 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.

Plus, you should also learn about these 2 warning signs we've spotted with Zhejiang East Crystal ElectronicLtd (including 1 which is a bit concerning).

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.