Chengdu ALD Aviation Manufacturing Corporation (SZSE:300696) shareholders are no doubt pleased to see that the share price has bounced 37% 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 17% over that time.

Since its price has surged higher, you could be forgiven for thinking Chengdu ALD Aviation Manufacturing is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 20.8x, considering almost half the companies in China's Aerospace & Defense industry have P/S ratios below 6.2x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Has Chengdu ALD Aviation Manufacturing Performed Recently?

While the industry has experienced revenue growth lately, Chengdu ALD Aviation Manufacturing's revenue has gone into reverse gear, which is not great. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. 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 Chengdu ALD Aviation Manufacturing?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Chengdu ALD Aviation Manufacturing's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 45% decrease to the company's top line. As a result, revenue from three years ago have also fallen 42% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Shifting to the future, estimates from the one analyst covering the company suggest revenue should grow by 41% over the next year. That's shaping up to be similar to the 39% growth forecast for the broader industry.

In light of this, it's curious that Chengdu ALD Aviation Manufacturing's P/S sits above the majority of other companies. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. Although, additional gains will be difficult to achieve as this level of revenue growth is likely to weigh down the share price eventually.

The Final Word

Chengdu ALD Aviation Manufacturing's 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.

Seeing as its revenues are forecast to grow in line with the wider industry, it would appear that Chengdu ALD Aviation Manufacturing currently trades on a higher than expected P/S. Right now we are uncomfortable with the relatively high share price as the predicted future revenues aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Before you take the next step, you should know about the 1 warning sign for Chengdu ALD Aviation Manufacturing that we have uncovered.

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.

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