When you see that almost half of the companies in the Machinery industry in China have price-to-sales ratios (or "P/S") below 2.8x, Guangdong Topstar Technology Co., Ltd. (SZSE:300607) looks to be giving off some sell signals with its 3.9x 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 Guangdong Topstar Technology Has Been Performing

Guangdong Topstar Technology hasn't been tracking well recently as its declining revenue compares poorly to other companies, which have seen some growth in their revenues on average. It might be that many expect the dour revenue performance to recover substantially, which has kept the P/S from collapsing. If not, then existing shareholders may be extremely nervous about the viability of the share price.

How Is Guangdong Topstar Technology's Revenue Growth Trending?

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

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 28%. That put a dampener on the good run it was having over the longer-term as its three-year revenue growth is still a noteworthy 18% in total. 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.

Turning to the outlook, the next year should generate growth of 7.7% as estimated by the three analysts watching the company. With the industry predicted to deliver 22% growth, the company is positioned for a weaker revenue result.

With this in consideration, we believe it doesn't make sense that Guangdong Topstar Technology's P/S is outpacing its industry peers. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

What We Can Learn From Guangdong Topstar Technology's P/S?

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.

It comes as a surprise to see Guangdong Topstar Technology trade at such a high P/S given the revenue forecasts look less than stellar. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. At these price levels, investors should remain cautious, particularly if things don't improve.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Guangdong Topstar Technology (at least 1 which is a bit unpleasant), and understanding them should be part of your investment process.

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.