With a price-to-sales (or "P/S") ratio of 0.7x DaTang HuaYin Electric Power CO.,LTD (SHSE:600744) may be sending bullish signals at the moment, given that almost half of all the Renewable Energy companies in China have P/S ratios greater than 2x and even P/S higher than 5x are not unusual. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

What Does DaTang HuaYin Electric PowerLTD's P/S Mean For Shareholders?

For example, consider that DaTang HuaYin Electric PowerLTD'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. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

Do Revenue Forecasts Match The Low P/S Ratio?

There's an inherent assumption that a company should underperform the industry for P/S ratios like DaTang HuaYin Electric PowerLTD's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 18% decrease to the company's top line. As a result, revenue from three years ago have also fallen 4.1% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 9.7% shows it's an unpleasant look.

In light of this, it's understandable that DaTang HuaYin Electric PowerLTD'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. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

What We Can Learn From DaTang HuaYin Electric PowerLTD's P/S?

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.

As we suspected, our examination of DaTang HuaYin Electric PowerLTD revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set 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. If recent medium-term revenue trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

And what about other risks? Every company has them, and we've spotted 2 warning signs for DaTang HuaYin Electric PowerLTD you should know about.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.