Those holding PowerTECH Co., Ltd. (SZSE:301369) 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. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 32% in the last twelve months.

Following the firm bounce in price, PowerTECH may be sending very bearish signals at the moment with a price-to-sales (or "P/S") ratio of 14.6x, since almost half of all companies in the Semiconductor industry in China have P/S ratios under 6.1x and even P/S lower than 2x are not unusual. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How PowerTECH Has Been Performing

For example, consider that PowerTECH's financial performance has been poor lately as its revenue has been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as steep as PowerTECH's is when the company's growth is on track to outshine the industry decidedly.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 23%. That put a dampener on the good run it was having over the longer-term as its three-year revenue growth is still a noteworthy 5.0% in total. Accordingly, while they would have preferred to keep the run going, shareholders would be roughly satisfied with the medium-term rates of revenue growth.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 36% shows it's noticeably less attractive.

With this in mind, we find it worrying that PowerTECH'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 good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What Does PowerTECH's P/S Mean For Investors?

PowerTECH's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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 PowerTECH 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. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with PowerTECH (at least 2 which can't be ignored), and understanding these should be part of your investment process.

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.

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