When you see that almost half of the companies in the Chemicals industry in China have price-to-sales ratios (or "P/S") below 2.2x, New East New Materials Co., Ltd (SHSE:603110) looks to be giving off strong sell signals with its 11.9x P/S ratio. 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.

View our latest analysis for New East New Materials

How Has New East New Materials Performed Recently?

Revenue has risen at a steady rate over the last year for New East New Materials, which is generally not a bad outcome. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as New East New Materials' is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered a decent 5.0% gain to the company's revenues. Still, revenue has barely risen at all in aggregate from three years ago, which is not ideal. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Comparing that to the industry, which is predicted to deliver 29% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that New East New Materials' 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 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 New East New Materials' P/S?

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

The fact that New East New Materials 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. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You need to take note of risks, for example - New East New Materials has 4 warning signs (and 3 which are concerning) we think you should know about.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.