Weihai Huadong Automation Co., Ltd (SZSE:002248) shareholders would be excited to see that the share price has had a great month, posting a 26% gain and recovering from prior weakness. Looking back a bit further, it's encouraging to see the stock is up 27% in the last year.

After such a large jump in price, given around half the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 3.2x, you may consider Weihai Huadong Automation as a stock to avoid entirely with its 11.7x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

Check out our latest analysis for Weihai Huadong Automation

How Has Weihai Huadong Automation Performed Recently?

For instance, Weihai Huadong Automation's 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Weihai Huadong Automation would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered a frustrating 7.7% decrease to the company's top line. Even so, admirably revenue has lifted 46% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing revenue over that time, even though it had some hiccups along the way.

This is in contrast to the rest of the industry, which is expected to grow by 31% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this in mind, we find it worrying that Weihai Huadong Automation'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 Bottom Line On Weihai Huadong Automation's P/S

Shares in Weihai Huadong Automation have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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.

The fact that Weihai Huadong Automation 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. 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. 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.

You should always think about risks. Case in point, we've spotted 2 warning signs for Weihai Huadong Automation you should be aware of, and 1 of them makes us a bit uncomfortable.

If you're unsure about the strength of Weihai Huadong Automation'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.