SMS Electric Co.,Ltd.Zhengzhou (SZSE:002857) shareholders would be excited to see that the share price has had a great month, posting a 33% gain and recovering from prior weakness. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 28% in the last twelve months.

Since its price has surged higher, you could be forgiven for thinking SMS ElectricLtd.Zhengzhou is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 5.6x, considering almost half the companies in China's Electronic industry have P/S ratios below 3.5x. 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 SMS ElectricLtd.Zhengzhou Has Been Performing

Recent times have been quite advantageous for SMS ElectricLtd.Zhengzhou as its revenue has been rising very briskly. Perhaps the market is expecting future revenue performance to outperform the wider market, which has seemingly got people interested in the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For SMS ElectricLtd.Zhengzhou?

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

Retrospectively, the last year delivered an exceptional 68% gain to the company's top line. Pleasingly, revenue has also lifted 55% in aggregate from three years ago, thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been superb for the company.

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

With this information, we find it concerning that SMS ElectricLtd.Zhengzhou 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. 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.

The Final Word

Shares in SMS ElectricLtd.Zhengzhou have seen a strong upwards swing lately, which has really helped boost its P/S figure. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of SMS ElectricLtd.Zhengzhou 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 there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

There are also other vital risk factors to consider and we've discovered 4 warning signs for SMS ElectricLtd.Zhengzhou (2 are a bit unpleasant!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com