With a median price-to-sales (or "P/S") ratio of close to 1.9x in the Chemicals industry in China, you could be forgiven for feeling indifferent about Tianqi Lithium Corporation's (SZSE:002466) P/S ratio of 1.5x. Although, it's not wise to simply ignore the P/S without explanation as investors may be disregarding a distinct opportunity or a costly mistake.

How Tianqi Lithium Has Been Performing

While the industry has experienced revenue growth lately, Tianqi Lithium's revenue has gone into reverse gear, which is not great. One possibility is that the P/S ratio is moderate because investors think this poor revenue performance will turn around. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The P/S Ratio?

The only time you'd be comfortable seeing a P/S like Tianqi Lithium's is when the company's growth is tracking the industry closely.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 32%. Spectacularly, three year revenue growth has ballooned by several orders of magnitude, despite the drawbacks experienced in the last 12 months. Therefore, it's fair to say the revenue growth recently has been superb for the company, but investors will want to ask why it is now in decline.

Looking ahead now, revenue is anticipated to slump, contracting by 14% each year during the coming three years according to the analysts following the company. Meanwhile, the broader industry is forecast to expand by 16% each year, which paints a poor picture.

In light of this, it's somewhat alarming that Tianqi Lithium's P/S sits in line with the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the negative growth outlook.

The Bottom Line On Tianqi Lithium's P/S

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

While Tianqi Lithium's P/S isn't anything out of the ordinary for companies in the industry, we didn't expect it given forecasts of revenue decline. With this in mind, we don't feel the current P/S is justified as declining revenues are unlikely to support a more positive sentiment for long. If we consider the revenue outlook, the P/S seems to indicate that potential investors may be paying a premium for the stock.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Tianqi Lithium that you should be aware of.

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