Guangdong Hongming Intelligent Joint Stock Co., Ltd. (SZSE:301105) shareholders that were waiting for something to happen have been dealt a blow with a 29% share price drop in the last month. The drop over the last 30 days has capped off a tough year for shareholders, with the share price down 32% in that time.

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 Guangdong Hongming Intelligent as a stock to avoid entirely with its 8.2x 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 Guangdong Hongming Intelligent's P/S Mean For Shareholders?

For example, consider that Guangdong Hongming Intelligent's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to still outplay most other companies over the coming period, which has kept the P/S from collapsing. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Guangdong Hongming Intelligent?

In order to justify its P/S ratio, Guangdong Hongming Intelligent would need to produce outstanding growth that's well in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 42%. This means it has also seen a slide in revenue over the longer-term as revenue is down 47% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 28% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we find it concerning that Guangdong Hongming Intelligent is trading at a P/S higher than the industry. 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 Guangdong Hongming Intelligent's P/S

A significant share price dive has done very little to deflate Guangdong Hongming Intelligent's very lofty 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 Guangdong Hongming Intelligent 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. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. 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.

It is also worth noting that we have found 2 warning signs for Guangdong Hongming Intelligent that you need to take into consideration.

If these risks are making you reconsider your opinion on Guangdong Hongming Intelligent, 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.