Sinodata Co., Ltd. (SZSE:002657) shares have continued their recent momentum with a 28% gain in the last month alone. Looking further back, the 16% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

Since its price has surged higher, given close to half the companies operating in China's Software industry have price-to-sales ratios (or "P/S") below 7.5x, you may consider Sinodata as a stock to potentially avoid with its 9x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does Sinodata's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Sinodata over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. 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?

The only time you'd be truly comfortable seeing a P/S as high as Sinodata's is when the company's growth is on track to outshine the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 25%. As a result, revenue from three years ago have also fallen 54% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 32% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Sinodata 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Final Word

The large bounce in Sinodata's shares has lifted the company's P/S handsomely. 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.

We've established that Sinodata currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. 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.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Sinodata that 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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