You may think that with a price-to-sales (or "P/S") ratio of 18.6x Strait Innovation Internet Co., Ltd. (SZSE:300300) is a stock to avoid completely, seeing as almost half of all the IT companies in China have P/S ratios under 4.2x and even P/S lower than 2x aren't out of the ordinary. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

Check out our latest analysis for Strait Innovation Internet

How Has Strait Innovation Internet Performed Recently?

As an illustration, revenue has deteriorated at Strait Innovation Internet over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do 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.

Is There Enough Revenue Growth Forecasted For Strait Innovation Internet?

The only time you'd be truly comfortable seeing a P/S as steep as Strait Innovation Internet's is when the company's growth is on track to outshine the industry decidedly.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 45%. As a result, revenue from three years ago have also fallen 51% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 49% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Strait Innovation Internet is trading at a P/S higher than the industry. 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 Strait Innovation Internet's P/S Mean For Investors?

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.

We've established that Strait Innovation Internet currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Strait Innovation Internet, and understanding should be part of your investment process.

If you're unsure about the strength of Strait Innovation Internet'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.