You may think that with a price-to-sales (or "P/S") ratio of 11.7x Shanghai Guao Electronic Technology Co., Ltd. (SZSE:300551) is a stock to avoid completely, seeing as almost half of all the Tech companies in China have P/S ratios under 4x and even P/S lower than 2x aren't out of the ordinary. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

See our latest analysis for Shanghai Guao Electronic Technology

How Has Shanghai Guao Electronic Technology Performed Recently?

With revenue growth that's exceedingly strong of late, Shanghai Guao Electronic Technology has been doing very well. 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. If not, then existing shareholders might be a little nervous about the viability of the share price.

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

In order to justify its P/S ratio, Shanghai Guao Electronic Technology would need to produce outstanding growth that's well in excess of the industry.

Taking a look back first, we see that the company grew revenue by an impressive 53% last year. Pleasingly, revenue has also lifted 60% in aggregate from three years ago, thanks to the last 12 months of growth. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 28% shows it's noticeably less attractive.

With this in mind, we find it worrying that Shanghai Guao Electronic Technology'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 Key Takeaway

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Shanghai Guao Electronic Technology 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. 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. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

Before you take the next step, you should know about the 2 warning signs for Shanghai Guao Electronic Technology that we have uncovered.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.