CloudWalk Technology Co., Ltd. (SHSE:688327) shareholders are no doubt pleased to see that the share price has bounced 26% 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 35% over that time.

Since its price has surged higher, CloudWalk Technology may be sending strong sell signals at present with a price-to-sales (or "P/S") ratio of 17.1x, when you consider almost half of the companies in the Software industry in China have P/S ratios under 4.9x and even P/S lower than 2x aren't out of the ordinary. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How CloudWalk Technology Has Been Performing

CloudWalk Technology certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. Perhaps the market is expecting future revenue performance to outperform the wider market, which has seemingly got people interested in the stock. 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 CloudWalk Technology's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 96% last year. Still, revenue has fallen 41% in total from three years ago, which is quite disappointing. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenues over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 26% shows it's an unpleasant look.

With this information, we find it concerning that CloudWalk Technology is trading at a P/S higher than the industry. 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.

What We Can Learn From CloudWalk Technology's P/S?

The strong share price surge has lead to CloudWalk Technology's P/S soaring as well. 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 CloudWalk Technology currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

A lot of potential risks can sit within a company's balance sheet. You can assess many of the main risks through our free balance sheet analysis for CloudWalk Technology with six simple checks.

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.