Xiamen XGMA Machinery Company Limited's (SHSE:600815) price-to-sales (or "P/S") ratio of 5.6x may look like a poor investment opportunity when you consider close to half the companies in the Machinery industry in China have P/S ratios below 2.8x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Xiamen XGMA Machinery's Recent Performance Look Like?

As an illustration, revenue has deteriorated at Xiamen XGMA Machinery over the last year, which is not ideal at all. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. 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?

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

Retrospectively, the last year delivered a frustrating 26% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 49% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

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 information, we find it concerning that Xiamen XGMA Machinery is trading at a P/S higher than the industry. 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. 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 Final Word

While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our examination of Xiamen XGMA Machinery 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. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Xiamen XGMA Machinery that you should be aware of.

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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