With a price-to-sales (or "P/S") ratio of 16.2x AVIT Ltd. (SZSE:300264) may be sending very bearish signals at the moment, given that almost half of all the IT companies in China have P/S ratios under 4.5x and even P/S lower than 2x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does AVIT's P/S Mean For Shareholders?

Recent times have been quite advantageous for AVIT as its revenue has been rising very briskly. It seems that many are expecting the strong revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

What Are Revenue Growth Metrics Telling Us About The High P/S?

AVIT's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 82%. As a result, it also grew revenue by 21% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 20% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this information, we find it concerning that AVIT is trading at a P/S higher than the industry. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

What Does AVIT's P/S Mean For Investors?

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.

The fact that AVIT currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

Before you take the next step, you should know about the 1 warning sign for AVIT that we have uncovered.

If you're unsure about the strength of AVIT's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.