Guangzhou Tongda Auto Electric Co., Ltd (SHSE:603390) shareholders are no doubt pleased to see that the share price has bounced 39% in the last month, although it is still struggling to make up recently lost ground. Looking further back, the 15% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.

After such a large jump in price, you could be forgiven for thinking Guangzhou Tongda Auto Electric is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 5.2x, considering almost half the companies in China's Auto Components industry have P/S ratios below 2.5x. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

How Guangzhou Tongda Auto Electric Has Been Performing

Revenue has risen firmly for Guangzhou Tongda Auto Electric recently, which is pleasing to see. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Guangzhou Tongda Auto Electric?

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

Retrospectively, the last year delivered a decent 8.0% gain to the company's revenues. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 15% in total over the last three years. 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 22% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Guangzhou Tongda Auto Electric's P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Final Word

The strong share price surge has lead to Guangzhou Tongda Auto Electric's P/S soaring as well. 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.

Our examination of Guangzhou Tongda Auto Electric 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. 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.

Having said that, be aware Guangzhou Tongda Auto Electric is showing 1 warning sign in our investment analysis, you should know about.

If these risks are making you reconsider your opinion on Guangzhou Tongda Auto Electric, explore our interactive list of high quality stocks to get an idea of what else is out there.

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