It's not a stretch to say that EFORT Intelligent Equipment Co., Ltd.'s (SHSE:688165) price-to-sales (or "P/S") ratio of 3x right now seems quite "middle-of-the-road" for companies in the Machinery industry in China, where the median P/S ratio is around 3.1x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

View our latest analysis for EFORT Intelligent Equipment

How EFORT Intelligent Equipment Has Been Performing

With revenue growth that's exceedingly strong of late, EFORT Intelligent Equipment has been doing very well. Perhaps the market is expecting future revenue performance to taper off, which has kept the P/S from rising. Those who are bullish on EFORT Intelligent Equipment will be hoping that this isn't the case, so that they can pick up the stock at a lower valuation.

Do Revenue Forecasts Match The P/S Ratio?

There's an inherent assumption that a company should be matching the industry for P/S ratios like EFORT Intelligent Equipment's to be considered reasonable.

If we review the last year of revenue growth, the company posted a terrific increase of 38%. Pleasingly, revenue has also lifted 55% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 31% shows it's noticeably less attractive.

In light of this, it's curious that EFORT Intelligent Equipment's P/S sits in line with the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are willing to pay up for exposure to the stock. Maintaining these prices will be difficult to achieve as a continuation of recent revenue trends is likely to weigh down the shares eventually.

The Final Word

Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We've established that EFORT Intelligent Equipment's average P/S is a bit surprising since its recent three-year growth is lower than the wider industry forecast. When we see weak revenue with slower than industry growth, we suspect the share price is at risk of declining, bringing the P/S back in line with expectations. Unless the recent medium-term conditions improve, it's hard to accept the current share price as fair value.

You should always think about risks. Case in point, we've spotted 1 warning sign for EFORT Intelligent Equipment you should be aware of.

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.