The Shaanxi Aerospace Power Hi-Tech Co., Ltd. (SHSE:600343) share price has fared very poorly over the last month, falling by a substantial 26%. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 18% share price drop.

In spite of the heavy fall in price, given around half the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.5x, you may still consider Shaanxi Aerospace Power Hi-Tech as a stock to avoid entirely with its 5.4x 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.

What Does Shaanxi Aerospace Power Hi-Tech's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Shaanxi Aerospace Power Hi-Tech 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shaanxi Aerospace Power Hi-Tech's to be considered reasonable.

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 29%. The last three years don't look nice either as the company has shrunk revenue by 43% in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 28% 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 Shaanxi Aerospace Power Hi-Tech's 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. 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 Shaanxi Aerospace Power Hi-Tech's P/S Mean For Investors?

Even after such a strong price drop, Shaanxi Aerospace Power Hi-Tech's P/S still exceeds the industry median significantly. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

Our examination of Shaanxi Aerospace Power Hi-Tech 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. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. 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.

Plus, you should also learn about this 1 warning sign we've spotted with Shaanxi Aerospace Power Hi-Tech.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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