When you see that almost half of the companies in the Commercial Services industry in China have price-to-sales ratios (or "P/S") below 3x, Xinlun New Materials Co., Ltd. (SZSE:002341) looks to be giving off strong sell signals with its 5.1x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

View our latest analysis for Xinlun New Materials

What Does Xinlun New Materials' Recent Performance Look Like?

As an illustration, revenue has deteriorated at Xinlun New Materials over the last year, which is not ideal at all. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Xinlun New Materials' Revenue Growth Trending?

Xinlun New Materials' 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, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 25%. The last three years don't look nice either as the company has shrunk revenue by 71% in aggregate. 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 31% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Xinlun New Materials' P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

What We Can Learn From Xinlun New Materials' P/S?

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.

Our examination of Xinlun New Materials 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. 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. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

You should always think about risks. Case in point, we've spotted 2 warning signs for Xinlun New Materials you should be aware of, and 1 of them doesn't sit too well with us.

If these risks are making you reconsider your opinion on Xinlun New Materials, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.