Guangdong DP Co.,Ltd. (SZSE:300808) shares have had a really impressive month, gaining 37% after a shaky period beforehand. Looking back a bit further, it's encouraging to see the stock is up 35% in the last year.

Since its price has surged higher, given around half the companies in China's Electrical industry have price-to-sales ratios (or "P/S") below 2.3x, you may consider Guangdong DPLtd as a stock to avoid entirely with its 6.1x P/S ratio. 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 Guangdong DPLtd Has Been Performing

For instance, Guangdong DPLtd's receding revenue in recent times would have to be some food for thought. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For Guangdong DPLtd?

In order to justify its P/S ratio, Guangdong DPLtd would need to produce outstanding growth that's well in excess of the industry.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 9.8%. As a result, revenue from three years ago have also fallen 33% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 24% shows it's an unpleasant look.

In light of this, it's alarming that Guangdong DPLtd'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 Final Word

The strong share price surge has lead to Guangdong DPLtd'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 Guangdong DPLtd 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. 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. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 4 warning signs with Guangdong DPLtd (at least 3 which make us uncomfortable), and understanding them should be part of your investment process.

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.