Guangdong Songfa Ceramics Co.,Ltd. (SHSE:603268) 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. Longer-term shareholders would now have taken a real hit with the stock declining 6.8% in the last year.

Although its price has dipped substantially, you could still be forgiven for thinking Guangdong Songfa CeramicsLtd is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 8x, considering almost half the companies in China's Consumer Durables industry have P/S ratios below 1.7x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Guangdong Songfa CeramicsLtd Has Been Performing

As an illustration, revenue has deteriorated at Guangdong Songfa CeramicsLtd 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.

How Is Guangdong Songfa CeramicsLtd's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as steep as Guangdong Songfa CeramicsLtd's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered a frustrating 26% decrease to the company's top line. As a result, revenue from three years ago have also fallen 47% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 12% 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 Guangdong Songfa CeramicsLtd's P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Even after such a strong price drop, Guangdong Songfa CeramicsLtd'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 Guangdong Songfa CeramicsLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Guangdong Songfa CeramicsLtd, and understanding them should be part of your investment process.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.