Shenzhen Gongjin Electronics Co., Ltd.'s (SHSE:603118) price-to-sales (or "P/S") ratio of 0.6x might make it look like a strong buy right now compared to the Communications industry in China, where around half of the companies have P/S ratios above 3.8x and even P/S above 7x are quite common. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so limited.

What Does Shenzhen Gongjin Electronics' P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Shenzhen Gongjin Electronics over the last year, which is not ideal at all. It might be that many expect the disappointing revenue performance to continue or accelerate, which has repressed the P/S. Those who are bullish on Shenzhen Gongjin Electronics will be hoping that this isn't the case so that they can pick up the stock at a lower valuation.

Do Revenue Forecasts Match The Low P/S Ratio?

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

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 22%. This means it has also seen a slide in revenue over the longer-term as revenue is down 14% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 48% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's understandable that Shenzhen Gongjin Electronics' P/S would sit below the majority of other companies. 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. Even just maintaining these prices could be difficult to achieve as recent revenue trends are already weighing down the shares.

The Final Word

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.

It's no surprise that Shenzhen Gongjin Electronics maintains its low P/S off the back of its sliding revenue over the medium-term. Right now shareholders are accepting the low P/S as they concede future revenue probably won't provide any pleasant surprises either. If recent medium-term revenue trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

Having said that, be aware Shenzhen Gongjin Electronics is showing 2 warning signs in our investment analysis, you should know about.

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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