Guangdong Rongtai Industry Co.,Ltd (SHSE:600589) shareholders that were waiting for something to happen have been dealt a blow with a 33% share price drop in the last month. Looking at the bigger picture, even after this poor month the stock is up 56% in the last year.

Even after such a large drop in price, given around half the companies in China's Chemicals industry have price-to-sales ratios (or "P/S") below 2.3x, you may still consider Guangdong Rongtai IndustryLtd as a stock to avoid entirely with its 5.7x 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.

View our latest analysis for Guangdong Rongtai IndustryLtd

How Guangdong Rongtai IndustryLtd Has Been Performing

Guangdong Rongtai IndustryLtd certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. Perhaps the market is expecting future revenue performance to outperform the wider market, which has seemingly got people interested in the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

Guangdong Rongtai IndustryLtd'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.

Taking a look back first, we see that the company grew revenue by an impressive 39% last year. Still, revenue has fallen 65% in total from three years ago, which is quite disappointing. 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 29% shows it's an unpleasant look.

In light of this, it's alarming that Guangdong Rongtai IndustryLtd'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.

What Does Guangdong Rongtai IndustryLtd's P/S Mean For Investors?

A significant share price dive has done very little to deflate Guangdong Rongtai IndustryLtd's very lofty 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 Guangdong Rongtai IndustryLtd 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.

It is also worth noting that we have found 4 warning signs for Guangdong Rongtai IndustryLtd that you need to take into consideration.

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.