You may think that with a price-to-sales (or "P/S") ratio of 10.1x Rockchip Electronics Co., Ltd. (SHSE:603893) is a stock to avoid completely, seeing as almost half of all the Semiconductor companies in China have P/S ratios under 5.6x and even P/S lower than 2x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Rockchip Electronics Has Been Performing

Rockchip Electronics certainly has been doing a good job lately as it's been growing revenue more than most other companies. It seems that many are expecting the strong revenue performance to persist, which has raised the P/S. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For Rockchip Electronics?

The only time you'd be truly comfortable seeing a P/S as steep as Rockchip Electronics' is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered an exceptional 29% gain to the company's top line. As a result, it also grew revenue by 8.8% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

Looking ahead now, revenue is anticipated to climb by 27% during the coming year according to the five analysts following the company. With the industry predicted to deliver 35% growth, the company is positioned for a weaker revenue result.

With this information, we find it concerning that Rockchip Electronics is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of revenue growth is likely to weigh heavily on the share price eventually.

The Bottom Line On Rockchip Electronics' 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.

We've concluded that Rockchip Electronics currently trades on a much higher than expected P/S since its forecast growth is lower than the wider industry. Right now we aren't comfortable with the high P/S as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

The company's balance sheet is another key area for risk analysis. Our free balance sheet analysis for Rockchip Electronics with six simple checks will allow you to discover any risks that could be an issue.

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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