When close to half the companies in the Chemicals industry in China have price-to-sales ratios (or "P/S") below 2.2x, you may consider Shanghai Kinlita Chemical Co., Ltd. (SZSE:300225) as a stock to potentially avoid with its 4x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does Shanghai Kinlita Chemical's Recent Performance Look Like?

The revenue growth achieved at Shanghai Kinlita Chemical over the last year would be more than acceptable for most companies. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Shanghai Kinlita Chemical?

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

Taking a look back first, we see that the company managed to grow revenues by a handy 8.2% last year. However, this wasn't enough as the latest three year period has seen an unpleasant 24% overall drop in revenue. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 25% shows it's an unpleasant look.

In light of this, it's alarming that Shanghai Kinlita Chemical's P/S sits above the majority of other companies. 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 Does Shanghai Kinlita Chemical'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.

Our examination of Shanghai Kinlita Chemical revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

It is also worth noting that we have found 2 warning signs for Shanghai Kinlita Chemical (1 is concerning!) that you need to take into consideration.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.