When close to half the companies in the Medical Equipment industry in China have price-to-sales ratios (or "P/S") below 5x, you may consider Hubei Huaqiang High-Tech Co., Ltd. (SHSE:688151) as a stock to avoid entirely with its 8.1x 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.

What Does Hubei Huaqiang High-Tech's P/S Mean For Shareholders?

Revenue has risen at a steady rate over the last year for Hubei Huaqiang High-Tech, which is generally not a bad outcome. One possibility is that the P/S ratio is high because investors think this good revenue growth will be enough to outperform the broader industry in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Hubei Huaqiang High-Tech?

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

Taking a look back first, we see that the company managed to grow revenues by a handy 6.5% last year. However, this wasn't enough as the latest three year period has seen an unpleasant 59% overall drop in revenue. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 28% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Hubei Huaqiang High-Tech's 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. 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.

The Key Takeaway

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.

We've established that Hubei Huaqiang High-Tech currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. 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 Hubei Huaqiang High-Tech (1 is concerning!) that we have uncovered.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.