Shenzhen AOTO Electronics Co., Ltd. (SZSE:002587) shares have had a really impressive month, gaining 25% after a shaky period beforehand. The last 30 days bring the annual gain to a very sharp 70%.

Following the firm bounce in price, Shenzhen AOTO Electronics may be sending very bearish signals at the moment with a price-to-sales (or "P/S") ratio of 7.3x, since almost half of all companies in the Electronic industry in China have P/S ratios under 4.5x and even P/S lower than 2x 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.

View our latest analysis for Shenzhen AOTO Electronics

What Does Shenzhen AOTO Electronics' P/S Mean For Shareholders?

For instance, Shenzhen AOTO Electronics' receding revenue in recent times would have to be some food for thought. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

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

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 27%. As a result, revenue from three years ago have also fallen 22% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 61% 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 AOTO Electronics' 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.

What Does Shenzhen AOTO Electronics' P/S Mean For Investors?

Shenzhen AOTO Electronics' P/S has grown nicely over the last month thanks to a handy boost in the share price. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

We've established that Shenzhen AOTO Electronics 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 the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Shenzhen AOTO Electronics (at least 1 which can't be ignored), and understanding them should be part of your investment process.

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.