When you see that almost half of the companies in the Machinery industry in China have price-to-sales ratios (or "P/S") below 2.9x, Shenyang Machine Tool Co., Ltd. (SZSE:000410) looks to be giving off strong sell signals with its 8.9x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

Check out our latest analysis for Shenyang Machine Tool

How Shenyang Machine Tool Has Been Performing

As an illustration, revenue has deteriorated at Shenyang Machine Tool over the last year, which is not ideal at all. 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. 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 Shenyang Machine Tool?

Shenyang Machine Tool's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Retrospectively, the last year delivered a frustrating 8.4% decrease to the company's top line. Still, the latest three year period has seen an excellent 42% 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.

This is in contrast to the rest of the industry, which is expected to grow by 29% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Shenyang Machine Tool 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. 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.

The Final Word

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.

The fact that Shenyang Machine Tool 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.

Before you take the next step, you should know about the 1 warning sign for Shenyang Machine Tool that we have uncovered.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.