Shandong Tongda Island New Materials Co.,Ltd. (SZSE:300321) shareholders won't be pleased to see that the share price has had a very rough month, dropping 29% and undoing the prior period's positive performance. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 17% share price drop.

Although its price has dipped substantially, you could still be forgiven for thinking Shandong Tongda Island New MaterialsLtd is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.7x, considering almost half the companies in China's Chemicals industry have P/S ratios below 2x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Shandong Tongda Island New MaterialsLtd Has Been Performing

For instance, Shandong Tongda Island New MaterialsLtd's receding revenue in recent times would have to be some food for thought. 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.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Shandong Tongda Island New MaterialsLtd's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 35% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 19% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Comparing that to the industry, which is predicted to deliver 27% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Shandong Tongda Island New MaterialsLtd's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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.

The Bottom Line On Shandong Tongda Island New MaterialsLtd's P/S

Despite the recent share price weakness, Shandong Tongda Island New MaterialsLtd's P/S remains higher than most other companies in the industry. 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.

We've established that Shandong Tongda Island New MaterialsLtd 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. 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.

Don't forget that there may be other risks. For instance, we've identified 3 warning signs for Shandong Tongda Island New MaterialsLtd (1 is a bit unpleasant) you should be aware of.

If you're unsure about the strength of Shandong Tongda Island New MaterialsLtd's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.