Hengli Industrial Development Group Co., Ltd. (SZSE:000622) shares have had a horrible month, losing 28% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 43% share price drop.

Even after such a large drop in price, given around half the companies in China's Auto Components industry have price-to-sales ratios (or "P/S") below 2.3x, you may still consider Hengli Industrial Development Group as a stock to avoid entirely with its 9.8x 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.

How Has Hengli Industrial Development Group Performed Recently?

For instance, Hengli Industrial Development Group's receding revenue in recent times would have to be some food for thought. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. 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?

In order to justify its P/S ratio, Hengli Industrial Development Group 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 26%. As a result, revenue from three years ago have also fallen 73% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 26% 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 Hengli Industrial Development Group 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.

The Key Takeaway

Hengli Industrial Development Group's shares may have suffered, but its P/S remains high. 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.

We've established that Hengli Industrial Development Group 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.

Before you take the next step, you should know about the 3 warning signs for Hengli Industrial Development Group (2 don't sit too well with us!) that we have uncovered.

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.