Unfortunately for some shareholders, the AVIT Ltd. (SZSE:300264) share price has dived 32% in the last thirty days, prolonging recent pain. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 35% in that time.

In spite of the heavy fall in price, given around half the companies in China's IT industry have price-to-sales ratios (or "P/S") below 3.2x, you may still consider AVIT as a stock to avoid entirely with its 22.8x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does AVIT's P/S Mean For Shareholders?

For example, consider that AVIT's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. 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?

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

Retrospectively, the last year delivered a frustrating 53% decrease to the company's top line. As a result, revenue from three years ago have also fallen 46% 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 40% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that AVIT 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

What Does AVIT's P/S Mean For Investors?

Even after such a strong price drop, AVIT's P/S still exceeds the industry median significantly. 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.

We've established that AVIT currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

And what about other risks? Every company has them, and we've spotted 3 warning signs for AVIT (of which 2 make us uncomfortable!) you should know about.

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.