With a price-to-sales (or "P/S") ratio of 9.8x Shenzhen InfoGem Technologies Co., Ltd. (SZSE:300085) may be sending very bearish signals at the moment, given that almost half of all the Software companies in China have P/S ratios under 6.2x and even P/S lower than 3x are not unusual. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

Check out our latest analysis for Shenzhen InfoGem Technologies

What Does Shenzhen InfoGem Technologies' P/S Mean For Shareholders?

Shenzhen InfoGem Technologies has been doing a decent job lately as it's been growing revenue at a reasonable pace. It might be that many expect the reasonable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

What Are Revenue Growth Metrics Telling Us About The High P/S?

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

Retrospectively, the last year delivered a decent 3.4% gain to the company's revenues. However, this wasn't enough as the latest three year period has seen an unpleasant 16% overall drop in revenue. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 36% 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 Shenzhen InfoGem Technologies' P/S exceeds that of its industry peers. 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 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.

What Does Shenzhen InfoGem Technologies' P/S Mean For Investors?

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.

We've established that Shenzhen InfoGem Technologies currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Shenzhen InfoGem Technologies that 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.