Shenzhen Soling Industrial Co.,Ltd (SZSE:002766) shares have continued their recent momentum with a 27% gain in the last month alone. Looking further back, the 25% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

After such a large jump in price, when almost half of the companies in China's Auto Components industry have price-to-sales ratios (or "P/S") below 2.8x, you may consider Shenzhen Soling IndustrialLtd as a stock not worth researching with its 6x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Shenzhen Soling IndustrialLtd

What Does Shenzhen Soling IndustrialLtd's P/S Mean For Shareholders?

Recent times have been quite advantageous for Shenzhen Soling IndustrialLtd as its revenue has been rising very briskly. The P/S ratio is probably high because investors think this strong revenue growth will be enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Shenzhen Soling IndustrialLtd's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shenzhen Soling IndustrialLtd's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 33% gain to the company's top line. Although, its longer-term performance hasn't been as strong with three-year revenue growth being relatively non-existent overall. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

In contrast to the company, the rest of the industry is expected to grow by 27% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Shenzhen Soling IndustrialLtd's P/S sits above the majority of other companies. 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 Bottom Line On Shenzhen Soling IndustrialLtd's P/S

Shares in Shenzhen Soling IndustrialLtd have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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 Shenzhen Soling IndustrialLtd 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

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

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.