Unfortunately for some shareholders, the Greatoo Intelligent Equipment Inc. (SZSE:002031) share price has dived 25% in the last thirty days, prolonging recent pain. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 21% share price drop.

Even after such a large drop in price, when almost half of the companies in China's Auto Components industry have price-to-sales ratios (or "P/S") below 2.2x, you may still consider Greatoo Intelligent Equipment as a stock not worth researching with its 7.1x 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 so lofty.

How Has Greatoo Intelligent Equipment Performed Recently?

As an illustration, revenue has deteriorated at Greatoo Intelligent Equipment 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

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 Greatoo Intelligent Equipment's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 18% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 63% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 25% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Greatoo Intelligent Equipment's P/S sits above the majority of other companies. 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 We Can Learn From Greatoo Intelligent Equipment's P/S?

Even after such a strong price drop, Greatoo Intelligent Equipment's P/S still exceeds the industry median significantly. Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that Greatoo Intelligent Equipment 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Plus, you should also learn about these 2 warning signs we've spotted with Greatoo Intelligent Equipment.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.