Those holding Shanghai Welltech Automation Co.,Ltd. (SZSE:002058) shares would be relieved that the share price has rebounded 27% in the last thirty days, but it needs to keep going to repair the recent damage it has caused to investor portfolios. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 9.3% in the last twelve months.

After such a large jump in price, Shanghai Welltech AutomationLtd may be sending strong sell signals at present with a price-to-sales (or "P/S") ratio of 10.4x, when you consider almost half of the companies in the Electronic industry in China have P/S ratios under 4x and even P/S lower than 2x aren't out of the ordinary. 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 Shanghai Welltech AutomationLtd's Recent Performance Look Like?

As an illustration, revenue has deteriorated at Shanghai Welltech AutomationLtd over the last year, which is not ideal at all. 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.

What Are Revenue Growth Metrics Telling Us About The High P/S?

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

Retrospectively, the last year delivered a frustrating 21% decrease to the company's top line. However, a few very strong years before that means that it was still able to grow revenue by an impressive 91% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been more than adequate for the company.

It's interesting to note that the rest of the industry is similarly expected to grow by 25% over the next year, which is fairly even with the company's recent medium-term annualised growth rates.

With this in mind, we find it intriguing that Shanghai Welltech AutomationLtd's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly average recent growth rates and are willing to pay up for exposure to the stock. Although, additional gains will be difficult to achieve as a continuation of recent revenue trends would weigh down the share price eventually.

What We Can Learn From Shanghai Welltech AutomationLtd's P/S?

Shanghai Welltech AutomationLtd's P/S has grown nicely over the last month thanks to a handy boost in the share price. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We didn't expect to see Shanghai Welltech AutomationLtd trade at such a high P/S considering its last three-year revenue growth has only been on par with the rest of the industry. Right now we are uncomfortable with the high P/S as this revenue performance isn't likely to support such positive sentiment for long. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 2 warning signs for Shanghai Welltech AutomationLtd (1 is significant!) that you need to take into consideration.

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.