North Industries Group Red Arrow Co., Ltd (SZSE:000519) shareholders that were waiting for something to happen have been dealt a blow with a 26% share price drop in the last month. For any long-term shareholders, the last month ends a year to forget by locking in a 55% share price decline.

Although its price has dipped substantially, you could still be forgiven for thinking North Industries Group Red Arrow is a stock not worth researching with a price-to-sales ratios (or "P/S") of 2.8x, considering almost half the companies in China's Machinery industry have P/S ratios below 2.3x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

How Has North Industries Group Red Arrow Performed Recently?

North Industries Group Red Arrow could be doing better as its revenue has been going backwards lately while most other companies have been seeing positive revenue growth. One possibility is that the P/S ratio is high because investors think this poor revenue performance will turn the corner. If not, then existing shareholders may be extremely nervous about the viability of the share price.

Do Revenue Forecasts Match The High P/S Ratio?

The only time you'd be truly comfortable seeing a P/S as high as North Industries Group Red Arrow's is when the company's growth is on track to outshine 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 35%. This means it has also seen a slide in revenue over the longer-term as revenue is down 16% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Shifting to the future, estimates from the dual analysts covering the company suggest revenue should grow by 41% over the next year. That's shaping up to be materially higher than the 27% growth forecast for the broader industry.

With this in mind, it's not hard to understand why North Industries Group Red Arrow's P/S is high relative to its industry peers. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.

The Key Takeaway

Despite the recent share price weakness, North Industries Group Red Arrow's P/S remains higher than most other companies in the industry. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that North Industries Group Red Arrow maintains its high P/S on the strength of its forecasted revenue growth being higher than the the rest of the Machinery industry, as expected. Right now shareholders are comfortable with the P/S as they are quite confident future revenues aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.

Before you settle on your opinion, we've discovered 2 warning signs for North Industries Group Red Arrow that you should be aware of.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.