The Tanac Automation Co., Ltd. (SZSE:300461) share price has fared very poorly over the last month, falling by a substantial 33%. The last month has meant the stock is now only up 6.2% during the last year.

In spite of the heavy fall in price, you could still be forgiven for thinking Tanac Automation is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 10x, considering almost half the companies in China's Machinery industry have P/S ratios below 2.3x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Tanac Automation Has Been Performing

It looks like revenue growth has deserted Tanac Automation recently, which is not something to boast about. Perhaps the market believes that revenue growth will improve markedly over current levels, inflating the P/S ratio. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Tanac Automation's Revenue Growth Trending?

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

Taking a look back first, we see that there was hardly any revenue growth to speak of for the company over the past year. Whilst it's an improvement, it wasn't enough to get the company out of the hole it was in, with revenue down 30% overall from three years ago. 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 27% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Tanac Automation'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 Key Takeaway

Even after such a strong price drop, Tanac Automation's P/S still exceeds the industry median significantly. 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.

We've established that Tanac Automation 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. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

You always need to take note of risks, for example - Tanac Automation has 1 warning sign we think you should be aware of.

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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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.