Weihai Huadong Automation Co., Ltd (SZSE:002248) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. The last 30 days bring the annual gain to a very sharp 27%.

Since its price has surged higher, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 3.2x, you may consider Weihai Huadong Automation as a stock not worth researching with its 11.7x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for Weihai Huadong Automation

How Has Weihai Huadong Automation Performed Recently?

As an illustration, revenue has deteriorated at Weihai Huadong Automation over the last year, which is not ideal at all. 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. 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 Weihai Huadong Automation?

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 7.7%. Still, the latest three year period has seen an excellent 46% overall rise in revenue, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing revenue over that time, even though it had some hiccups along the way.

Comparing that to the industry, which is predicted to deliver 31% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this information, we find it concerning that Weihai Huadong Automation is trading at a P/S higher than the industry. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 Bottom Line On Weihai Huadong Automation's P/S

Weihai Huadong Automation's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

The fact that Weihai Huadong Automation 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 see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. 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 2 warning signs for Weihai Huadong Automation you should be aware of, and 1 of them is a bit concerning.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.