The Shanghai Taihe Water Technology Development Co.,Ltd. (SHSE:605081) share price has fared very poorly over the last month, falling by a substantial 26%. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 36% in that time.

Even after such a large drop in price, given around half the companies in China's Commercial Services industry have price-to-sales ratios (or "P/S") below 2.7x, you may still consider Shanghai Taihe Water Technology DevelopmentLtd as a stock to avoid entirely with its 7.6x 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.

What Does Shanghai Taihe Water Technology DevelopmentLtd's P/S Mean For Shareholders?

For example, consider that Shanghai Taihe Water Technology DevelopmentLtd's financial performance has been poor lately as its revenue has been in decline. 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.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Shanghai Taihe Water Technology DevelopmentLtd would need to produce outstanding growth that's well in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 59%. The last three years don't look nice either as the company has shrunk revenue by 73% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 30% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Shanghai Taihe Water Technology DevelopmentLtd is trading at a P/S higher than the industry. 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.

The Key Takeaway

A significant share price dive has done very little to deflate Shanghai Taihe Water Technology DevelopmentLtd's very lofty P/S. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

Our examination of Shanghai Taihe Water Technology DevelopmentLtd revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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.

Before you take the next step, you should know about the 1 warning sign for Shanghai Taihe Water Technology DevelopmentLtd that we have uncovered.

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.