The Huaiji Dengyun Auto-parts (Holding) Co.,Ltd. (SZSE:002715) share price has softened a substantial 26% over the previous 30 days, handing back much of the gains the stock has made lately. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 15% share price drop.

Although its price has dipped substantially, given close to half the companies operating in China's Auto Components industry have price-to-sales ratios (or "P/S") below 2.2x, you may still consider Huaiji Dengyun Auto-parts (Holding)Ltd as a stock to potentially avoid with its 3.6x 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.

What Does Huaiji Dengyun Auto-parts (Holding)Ltd's P/S Mean For Shareholders?

For example, consider that Huaiji Dengyun Auto-parts (Holding)Ltd's financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. If not, then existing shareholders may be quite nervous about the viability of the share price.

How Is Huaiji Dengyun Auto-parts (Holding)Ltd's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as high as Huaiji Dengyun Auto-parts (Holding)Ltd's is when the company's growth is on track to outshine the industry.

Retrospectively, the last year delivered a frustrating 5.4% decrease to the company's top line. Regardless, revenue has managed to lift by a handy 18% in aggregate from three years ago, thanks to the earlier period of growth. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of revenue growth.

This is in contrast to the rest of the industry, which is expected to grow by 24% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Huaiji Dengyun Auto-parts (Holding)Ltd 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 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.

What We Can Learn From Huaiji Dengyun Auto-parts (Holding)Ltd's P/S?

There's still some elevation in Huaiji Dengyun Auto-parts (Holding)Ltd's P/S, even if the same can't be said for its share price recently. 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.

The fact that Huaiji Dengyun Auto-parts (Holding)Ltd currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. 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 there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

You should always think about risks. Case in point, we've spotted 1 warning sign for Huaiji Dengyun Auto-parts (Holding)Ltd you should be aware of.

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.