You may think that with a price-to-sales (or "P/S") ratio of 2.2x Xiamen Changelight Co., Ltd. (SZSE:300102) is definitely a stock worth checking out, seeing as almost half of all the Semiconductor companies in China have P/S ratios greater than 5.6x and even P/S above 10x aren't out of the ordinary. However, the P/S might be quite low for a reason and it requires further investigation to determine if it's justified.

How Xiamen Changelight Has Been Performing

Xiamen Changelight certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. One possibility is that the P/S ratio is low because investors think this strong revenue growth might actually underperform the broader industry in the near future. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

How Is Xiamen Changelight's Revenue Growth Trending?

In order to justify its P/S ratio, Xiamen Changelight would need to produce anemic growth that's substantially trailing the industry.

Taking a look back first, we see that the company grew revenue by an impressive 42% last year. Pleasingly, revenue has also lifted 64% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing revenue over that time.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 36% shows it's noticeably less attractive.

In light of this, it's understandable that Xiamen Changelight's P/S sits below the majority of other companies. It seems most investors are expecting to see the recent limited growth rates continue into the future and are only willing to pay a reduced amount for the stock.

The Key Takeaway

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.

As we suspected, our examination of Xiamen Changelight revealed its three-year revenue trends are contributing to its low P/S, given they look worse than current industry expectations. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Unless the recent medium-term conditions improve, they will continue to form a barrier for the share price around these levels.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Xiamen Changelight, and understanding should be part of your investment process.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.