When close to half the companies in the Chemicals industry in China have price-to-sales ratios (or "P/S") below 2.3x, you may consider Guangzhou Sanfu New Materials Technology Co.,Ltd (SHSE:688359) as a stock to avoid entirely with its 14.4x 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 Guangzhou Sanfu New Materials TechnologyLtd

How Has Guangzhou Sanfu New Materials TechnologyLtd Performed Recently?

The revenue growth achieved at Guangzhou Sanfu New Materials TechnologyLtd over the last year would be more than acceptable for most companies. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For Guangzhou Sanfu New Materials TechnologyLtd?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Guangzhou Sanfu New Materials TechnologyLtd's to be considered reasonable.

Retrospectively, the last year delivered a decent 12% gain to the company's revenues. The latest three year period has also seen an excellent 47% overall rise in revenue, aided somewhat by its short-term performance. Therefore, it's fair to say the revenue growth recently has been superb for the company.

This is in contrast to the rest of the industry, which is expected to grow by 28% over the next year, materially higher than the company's recent medium-term annualised growth rates.

In light of this, it's alarming that Guangzhou Sanfu New Materials TechnologyLtd'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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What Does Guangzhou Sanfu New Materials TechnologyLtd's P/S Mean For Investors?

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.

The fact that Guangzhou Sanfu New Materials TechnologyLtd currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Guangzhou Sanfu New Materials TechnologyLtd (1 is significant) 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.