With a price-to-sales (or "P/S") ratio of 0.7x Shenzhen Deren Electronic Co., Ltd. (SZSE:002055) may be sending very bullish signals at the moment, given that almost half of all the Electronic companies in China have P/S ratios greater than 3.3x and even P/S higher than 7x are not unusual. However, the P/S might be quite low for a reason and it requires further investigation to determine if it's justified.

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

For example, consider that Shenzhen Deren Electronic's financial performance has been poor lately as its revenue has been in decline. Perhaps the market believes the recent revenue performance isn't good enough to keep up the industry, causing the P/S ratio to suffer. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

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

In order to justify its P/S ratio, Shenzhen Deren Electronic would need to produce anemic growth that's substantially trailing the industry.

Retrospectively, the last year delivered a frustrating 29% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 29% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

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 understandable that Shenzhen Deren Electronic's P/S would sit below the majority of other companies. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. Even just maintaining these prices could be difficult to achieve as recent revenue trends are already weighing down the shares.

The Key Takeaway

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Shenzhen Deren Electronic confirms that the company's shrinking revenue over the past medium-term is a key factor in its low price-to-sales ratio, given the industry is projected to grow. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

It is also worth noting that we have found 3 warning signs for Shenzhen Deren Electronic that you need to take into consideration.

If you're unsure about the strength of Shenzhen Deren 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.

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