Sai MicroElectronics Inc.'s (SZSE:300456) price-to-sales (or "P/S") ratio of 7x may look like a poor investment opportunity when you consider close to half the companies in the Electronic industry in China have P/S ratios below 3.1x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Sai MicroElectronics' P/S Mean For Shareholders?

Recent times have been advantageous for Sai MicroElectronics as its revenues have been rising faster than most other companies. It seems the market expects this form will continue into the future, hence the elevated P/S ratio. However, if this isn't the case, investors might get caught out paying too much for the stock.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, Sai MicroElectronics would need to produce outstanding growth that's well in excess of the industry.

If we review the last year of revenue growth, the company posted a terrific increase of 81%. The strong recent performance means it was also able to grow revenue by 82% in total over the last three years. Accordingly, shareholders would have definitely welcomed those medium-term rates of revenue growth.

Shifting to the future, estimates from the one analyst covering the company suggest revenue should grow by 25% over the next year. With the industry predicted to deliver 29% growth, the company is positioned for a weaker revenue result.

In light of this, it's alarming that Sai MicroElectronics' P/S sits above the majority of other companies. It seems most investors are hoping for a turnaround in the company's business prospects, but the analyst cohort is not so confident this will happen. There's a good chance these shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the growth outlook.

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.

Despite analysts forecasting some poorer-than-industry revenue growth figures for Sai MicroElectronics, this doesn't appear to be impacting the P/S in the slightest. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

You should always think about risks. Case in point, we've spotted 2 warning signs for Sai MicroElectronics you should be aware of.

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.

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