With a price-to-sales (or "P/S") ratio of 2.2x Caihong Display Devices Co.,Ltd. (SHSE:600707) may be sending bullish signals at the moment, given that almost half of all the Electronic companies in China have P/S ratios greater than 3.4x and even P/S higher than 6x are not unusual. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's limited.

How Caihong Display DevicesLtd Has Been Performing

Recent times have been quite advantageous for Caihong Display DevicesLtd as its revenue has been rising very briskly. It might be that many expect the strong revenue performance to degrade substantially, which has repressed the P/S ratio. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

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

There's an inherent assumption that a company should underperform the industry for P/S ratios like Caihong Display DevicesLtd's to be considered reasonable.

If we review the last year of revenue growth, the company posted a terrific increase of 37%. However, this wasn't enough as the latest three year period has seen the company endure a nasty 4.4% drop in revenue in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 25% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we are not surprised that Caihong Display DevicesLtd is trading at a P/S lower than the industry. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

The Key Takeaway

Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

As we suspected, our examination of Caihong Display DevicesLtd revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. Right now shareholders are accepting the low P/S as they concede future revenue probably won't provide any pleasant surprises either. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

And what about other risks? Every company has them, and we've spotted 1 warning sign for Caihong Display DevicesLtd you should know about.

If these risks are making you reconsider your opinion on Caihong Display DevicesLtd, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com