Malion New Materials Co., Ltd. (SZSE:300586) shares have continued their recent momentum with a 30% gain in the last month alone. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 3.7% over the last year.

Since its price has surged higher, given close to half the companies operating in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2.3x, you may consider Malion New Materials as a stock to potentially avoid with its 3.7x 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 as high as it is.

How Malion New Materials Has Been Performing

For instance, Malion New Materials' receding revenue in recent times would have to be some food for thought. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. 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?

The only time you'd be truly comfortable seeing a P/S as high as Malion New Materials' is when the company's growth is on track to outshine the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 14%. This has soured the latest three-year period, which nevertheless managed to deliver a decent 6.1% overall rise in revenue. So we can start by confirming that the company has generally done a good job of growing revenue over that time, even though it had some hiccups along the way.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 25% shows it's noticeably less attractive.

With this information, we find it concerning that Malion New Materials is trading at a P/S higher than the industry. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Final Word

Malion New Materials' P/S is on the rise since its shares have risen strongly. 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.

Our examination of Malion New Materials revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

And what about other risks? Every company has them, and we've spotted 2 warning signs for Malion New Materials you should know about.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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