The Jinlihua Electric Co., Ltd. (SZSE:300069) share price has done very well over the last month, posting an excellent gain of 39%. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 12% in the last twelve months.
Following the firm bounce in price, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.7x, you may consider Jinlihua Electric as a stock not worth researching with its 7.3x 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.
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How Has Jinlihua Electric Performed Recently?
Jinlihua Electric certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. The P/S ratio is probably high because investors think this strong 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.
We don't have analyst forecasts, but you can see how recent trends are setting up the company for the future by checking out our free report on Jinlihua Electric's earnings, revenue and cash flow.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 Jinlihua Electric's to be considered reasonable.
Taking a look back first, we see that the company grew revenue by an impressive 98% last year. As a result, it also grew revenue by 20% in total over the last three years. Accordingly, shareholders would have probably been satisfied with the medium-term rates of revenue growth.
Comparing that to the industry, which is predicted to deliver 25% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.
With this in mind, we find it worrying that Jinlihua Electric's P/S exceeds that of its industry peers. 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
The strong share price surge has lead to Jinlihua Electric's P/S soaring as well. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.
Our examination of Jinlihua Electric revealed its poor three-year revenue trends aren't detracting from the P/S as much as we though, given they look worse than current industry expectations. 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 settle on your opinion, we've discovered 2 warning signs for Jinlihua Electric (1 doesn't sit too well with us!) that you should be aware of.
It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).
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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.