Ronglian Group Ltd.'s (SZSE:002642) price-to-sales (or "P/S") ratio of 1.9x might make it look like a strong buy right now compared to the IT industry in China, where around half of the companies have P/S ratios above 4.5x and even P/S above 8x are quite common. However, the P/S might be quite low for a reason and it requires further investigation to determine if it's justified.

View our latest analysis for Ronglian Group

What Does Ronglian Group's Recent Performance Look Like?

For example, consider that Ronglian Group's financial performance has been poor lately as its revenue has been in decline. One possibility is that the P/S is low because investors think the company won't do enough to avoid underperforming the broader industry in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

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

There's an inherent assumption that a company should far underperform the industry for P/S ratios like Ronglian Group's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 22% decrease to the company's top line. The last three years don't look nice either as the company has shrunk revenue by 2.4% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 49% shows it's an unpleasant look.

With this information, we are not surprised that Ronglian Group is trading at a P/S lower than the industry. Nonetheless, there's no guarantee the P/S has reached a floor yet with revenue going in reverse. Even just maintaining these prices could be difficult to achieve as recent revenue trends are already weighing down the shares.

What Does Ronglian Group's P/S Mean For Investors?

Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

It's no surprise that Ronglian Group maintains its low P/S off the back of its sliding revenue over the medium-term. Right now shareholders are accepting the low P/S as they concede future revenue probably won't provide any pleasant surprises either. If recent medium-term revenue trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

There are also other vital risk factors to consider before investing and we've discovered 1 warning sign for Ronglian Group that you should be aware of.

If you're unsure about the strength of Ronglian Group'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.