Shenzhen Nanshan Power Co., Ltd. (SZSE:000037) shares have had a horrible month, losing 25% after a relatively good period beforehand. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 31% in that time.

Although its price has dipped substantially, when almost half of the companies in China's Electric Utilities industry have price-to-sales ratios (or "P/S") below 1.5x, you may still consider Shenzhen Nanshan Power as a stock not worth researching with its 8.4x 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.

How Has Shenzhen Nanshan Power Performed Recently?

As an illustration, revenue has deteriorated at Shenzhen Nanshan Power 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

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

Retrospectively, the last year delivered a frustrating 23% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 34% 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 7.5% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Shenzhen Nanshan Power's P/S sits above the majority of other companies. 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.

What We Can Learn From Shenzhen Nanshan Power's P/S?

A significant share price dive has done very little to deflate Shenzhen Nanshan Power's very lofty P/S. 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.

Our examination of Shenzhen Nanshan Power 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. 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. 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.

Before you take the next step, you should know about the 2 warning signs for Shenzhen Nanshan Power that we have uncovered.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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