Shenzhen Coship Electronics Co., Ltd. (SZSE:002052) shareholders are no doubt pleased to see that the share price has bounced 55% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 25% over that time.

Since its price has surged higher, given around half the companies in China's Communications industry have price-to-sales ratios (or "P/S") below 3.6x, you may consider Shenzhen Coship Electronics as a stock to avoid entirely with its 5.9x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

How Has Shenzhen Coship Electronics Performed Recently?

As an illustration, revenue has deteriorated at Shenzhen Coship Electronics over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

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

Retrospectively, the last year delivered a frustrating 46% decrease to the company's top line. As a result, revenue from three years ago have also fallen 24% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 48% shows it's an unpleasant look.

With this in mind, we find it worrying that Shenzhen Coship Electronics' P/S exceeds that of its industry peers. 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 Final Word

Shenzhen Coship Electronics' P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

We've established that Shenzhen Coship Electronics 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. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Shenzhen Coship Electronics, and understanding these should be part of your investment process.

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.

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