The Huawen Media Group (SZSE:000793) share price has softened a substantial 34% over the previous 30 days, handing back much of the gains the stock has made lately. The last month has meant the stock is now only up 7.0% during the last year.

In spite of the heavy fall in price, you could still be forgiven for thinking Huawen Media Group is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 11.8x, considering almost half the companies in China's Media industry have P/S ratios below 3.3x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Huawen Media Group's P/S Mean For Shareholders?

For example, consider that Huawen Media Group'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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Huawen Media Group?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Huawen Media Group's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 14% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 71% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 12% 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 Huawen Media Group'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 Final Word

Huawen Media Group's shares may have suffered, but its P/S remains high. 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 Huawen Media Group currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. 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.

Before you take the next step, you should know about the 1 warning sign for Huawen Media Group that we have uncovered.

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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