When close to half the companies in the Auto Components industry in China have price-to-sales ratios (or "P/S") below 2.6x, you may consider Guangzhou Tongda Auto Electric Co., Ltd (SHSE:603390) as a stock to avoid entirely with its 6.3x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

What Does Guangzhou Tongda Auto Electric's P/S Mean For Shareholders?

The revenue growth achieved at Guangzhou Tongda Auto Electric over the last year would be more than acceptable for most companies. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Guangzhou Tongda Auto Electric's Revenue Growth Trending?

Guangzhou Tongda Auto Electric's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

If we review the last year of revenue growth, the company posted a worthy increase of 11%. Still, revenue has barely risen at all in aggregate from three years ago, which is not ideal. So it appears to us that the company has had a mixed result in terms of growing revenue over that time.

This is in contrast to the rest of the industry, which is expected to grow by 24% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Guangzhou Tongda Auto Electric is trading at a P/S higher than the industry. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What Does Guangzhou Tongda Auto Electric's P/S Mean For Investors?

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 Guangzhou Tongda Auto Electric revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

You need to take note of risks, for example - Guangzhou Tongda Auto Electric has 2 warning signs (and 1 which can't be ignored) we think you should know about.

If you're unsure about the strength of Guangzhou Tongda Auto Electric'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.