Zhejiang NetSun Co., Ltd. (SZSE:002095) shareholders are no doubt pleased to see that the share price has bounced 28% in the last month, although it is still struggling to make up recently lost ground. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 30% over that time.

Following the firm bounce in price, you could be forgiven for thinking Zhejiang NetSun is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 10.3x, considering almost half the companies in China's Trade Distributors industry have P/S ratios below 0.7x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Zhejiang NetSun's Recent Performance Look Like?

For instance, Zhejiang NetSun's receding revenue in recent times would have to be some food for thought. 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Zhejiang NetSun's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Zhejiang NetSun's to be considered reasonable.

Retrospectively, the last year delivered a frustrating 5.8% decrease to the company's top line. This has soured the latest three-year period, which nevertheless managed to deliver a decent 24% overall rise in revenue. So we can start by confirming that the company has generally done a good job of growing revenue over that time, even though it had some hiccups along the way.

This is in contrast to the rest of the industry, which is expected to grow by 17% over the next year, materially higher than the company's recent medium-term annualised growth rates.

With this information, we find it concerning that Zhejiang NetSun is trading at a P/S higher than the industry. It seems most investors are ignoring the fairly limited recent growth rates 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

Shares in Zhejiang NetSun have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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.

The fact that Zhejiang NetSun currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

Before you take the next step, you should know about the 2 warning signs for Zhejiang NetSun (1 can't be ignored!) that we have uncovered.

If you're unsure about the strength of Zhejiang NetSun's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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