When you see that almost half of the companies in the Retail Distributors industry in China have price-to-sales ratios (or "P/S") below 0.4x, Liaoning Cheng Da Co., Ltd. (SHSE:600739) looks to be giving off some sell signals with its 1.2x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Liaoning Cheng Da Has Been Performing

As an illustration, revenue has deteriorated at Liaoning Cheng Da over the last year, which is not ideal at all. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

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

Liaoning Cheng Da's P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

Retrospectively, the last year delivered a frustrating 15% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 37% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 32% shows it's an unpleasant look.

In light of this, it's alarming that Liaoning Cheng Da's P/S sits above the majority of other companies. 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 Bottom Line On Liaoning Cheng Da's P/S

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Liaoning Cheng Da 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. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

You should always think about risks. Case in point, we've spotted 4 warning signs for Liaoning Cheng Da you should be aware of, and 2 of them are significant.

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.

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