Hangzhou Mdk Opto Electronics Co.,Ltd's (SHSE:688079) price-to-sales (or "P/S") ratio of 8x may look like a poor investment opportunity when you consider close to half the companies in the Electronic industry in China have P/S ratios below 3.5x. 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 Hangzhou Mdk Opto ElectronicsLtd Has Been Performing

For example, consider that Hangzhou Mdk Opto ElectronicsLtd's financial performance has been poor lately as its revenue has been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Hangzhou Mdk Opto ElectronicsLtd's Revenue Growth Trending?

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

Retrospectively, the last year delivered a frustrating 15% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 22% in total over the last three years. Accordingly, shareholders would have felt downbeat about 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 downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Hangzhou Mdk Opto ElectronicsLtd'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.

What We Can Learn From Hangzhou Mdk Opto ElectronicsLtd's P/S?

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.

We've established that Hangzhou Mdk Opto ElectronicsLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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 recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

You should always think about risks. Case in point, we've spotted 3 warning signs for Hangzhou Mdk Opto ElectronicsLtd you should be aware of, and 2 of them are significant.

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.