Wuxi Huadong Heavy Machinery Co., Ltd. (SZSE:002685) shares have had a really impressive month, gaining 31% after a shaky period beforehand. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 23% in the last twelve months.

After such a large jump in price, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.3x, you may consider Wuxi Huadong Heavy Machinery as a stock not worth researching with its 5.3x P/S ratio. 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 Wuxi Huadong Heavy Machinery's Recent Performance Look Like?

For instance, Wuxi Huadong Heavy Machinery's receding revenue in recent times would have to be some food for thought. 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. 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, Wuxi Huadong Heavy Machinery would need to produce outstanding growth that's well in excess of the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 58%. This means it has also seen a slide in revenue over the longer-term as revenue is down 93% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 22% shows it's an unpleasant look.

In light of this, it's alarming that Wuxi Huadong Heavy Machinery's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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.

The Final Word

Wuxi Huadong Heavy Machinery's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

We've established that Wuxi Huadong Heavy Machinery currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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 the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Wuxi Huadong Heavy Machinery (1 shouldn't be ignored) you should be aware of.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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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