Those holding Routon Electronic Co., Ltd. (SHSE:600355) shares would be relieved that the share price has rebounded 28% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. Looking further back, the 15% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Since its price has surged higher, when almost half of the companies in China's Tech industry have price-to-sales ratios (or "P/S") below 3.2x, you may consider Routon Electronic as a stock not worth researching with its 13.4x 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.

What Does Routon Electronic's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Routon Electronic over the last year, which is not ideal at all. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

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

Retrospectively, the last year delivered a frustrating 16% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 24% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 25% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Routon Electronic's P/S exceeds that of its industry peers. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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 Routon Electronic's P/S Mean For Investors?

The strong share price surge has lead to Routon Electronic's P/S soaring as well. 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.

We've established that Routon Electronic currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. 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.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Routon Electronic that you should be aware of.

If you're unsure about the strength of Routon Electronic'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.