The Zhejiang Yangfan New Materials Co., Ltd. (SZSE:300637) share price has done very well over the last month, posting an excellent gain of 27%. Looking back a bit further, it's encouraging to see the stock is up 39% in the last year.

Since its price has surged higher, you could be forgiven for thinking Zhejiang Yangfan New Materials is a stock not worth researching with a price-to-sales ratios (or "P/S") of 3.5x, considering almost half the companies in China's Chemicals industry have P/S ratios below 2x. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

What Does Zhejiang Yangfan New Materials' Recent Performance Look Like?

For instance, Zhejiang Yangfan New Materials' 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.

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

Zhejiang Yangfan New Materials' P/S ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the industry.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 7.4%. That put a dampener on the good run it was having over the longer-term as its three-year revenue growth is still a noteworthy 18% in total. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable for the company.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 23% shows it's noticeably less attractive.

In light of this, it's alarming that Zhejiang Yangfan New Materials' P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What We Can Learn From Zhejiang Yangfan New Materials' P/S?

Zhejiang Yangfan New Materials shares have taken a big step in a northerly direction, but its P/S is elevated as a result. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

Our examination of Zhejiang Yangfan New Materials 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. Right now we aren't comfortable with the high P/S as this revenue performance isn't likely to support such positive sentiment for long. 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.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Zhejiang Yangfan New Materials, and understanding them 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.