Despite an already strong run, Hangzhou Zhongheng Electric Co., Ltd (SZSE:002364) shares have been powering on, with a gain of 36% in the last thirty days. The last 30 days bring the annual gain to a very sharp 35%.

Following the firm bounce in price, given close to half the companies operating in China's Electrical industry have price-to-sales ratios (or "P/S") below 2.4x, you may consider Hangzhou Zhongheng Electric as a stock to potentially avoid with its 3.1x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Hangzhou Zhongheng Electric Has Been Performing

Revenue has risen firmly for Hangzhou Zhongheng Electric recently, which is pleasing to see. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

There's an inherent assumption that a company should outperform the industry for P/S ratios like Hangzhou Zhongheng Electric's to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 12%. However, due to its less than impressive performance prior to this period, revenue growth is practically non-existent over the last three years overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Comparing that to the industry, which is predicted to deliver 25% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that Hangzhou Zhongheng Electric's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Final Word

Hangzhou Zhongheng Electric's P/S is on the rise since its shares have risen strongly. 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.

Our examination of Hangzhou Zhongheng Electric 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. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

There are also other vital risk factors to consider and we've discovered 2 warning signs for Hangzhou Zhongheng Electric (1 is a bit unpleasant!) that you should be aware of before investing here.

If these risks are making you reconsider your opinion on Hangzhou Zhongheng Electric, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.