Unfortunately for some shareholders, the Xiamen Annie Co., Ltd. (SZSE:002235) share price has dived 25% in the last thirty days, prolonging recent pain. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 38% share price drop.

Even after such a large drop in price, given around half the companies in China's Forestry industry have price-to-sales ratios (or "P/S") below 1.6x, you may still consider Xiamen Annie as a stock to avoid entirely with its 8.2x 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 Xiamen Annie's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Xiamen Annie over the last year, which is not ideal at all. 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

What Are Revenue Growth Metrics Telling Us About The High P/S?

Xiamen Annie'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 30% decrease to the company's top line. As a result, revenue from three years ago have also fallen 24% 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 14% 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 Xiamen Annie is trading at a P/S higher than the industry. 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 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

Even after such a strong price drop, Xiamen Annie's P/S still exceeds the industry median significantly. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Xiamen Annie 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. 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.

Plus, you should also learn about this 1 warning sign we've spotted with Xiamen Annie.

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.