When close to half the companies in the Machinery industry in China have price-to-sales ratios (or "P/S") below 3.3x, you may consider Xiamen Zhongchuang Environmental Technology Co., Ltd (SZSE:300056) as a stock to avoid entirely with its 5.7x 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.

View our latest analysis for Xiamen Zhongchuang Environmental Technology

How Xiamen Zhongchuang Environmental Technology Has Been Performing

For example, consider that Xiamen Zhongchuang Environmental Technology's financial performance has been poor lately as its revenue has been in decline. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

What Are Revenue Growth Metrics Telling Us About The High P/S?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Xiamen Zhongchuang Environmental Technology's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 51%. This means it has also seen a slide in revenue over the longer-term as revenue is down 68% 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 33% shows it's an unpleasant look.

With this in mind, we find it worrying that Xiamen Zhongchuang Environmental Technology's P/S exceeds that of its industry peers. 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. 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 Bottom Line On Xiamen Zhongchuang Environmental Technology's P/S

We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of Xiamen Zhongchuang Environmental Technology revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

Having said that, be aware Xiamen Zhongchuang Environmental Technology is showing 1 warning sign in our investment analysis, you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.