Xiamen Zhongchuang Environmental Technology Co., Ltd (SZSE:300056) shareholders won't be pleased to see that the share price has had a very rough month, dropping 26% and undoing the prior period's positive performance. Looking back over the past twelve months the stock has been a solid performer regardless, with a gain of 23%.

Even after such a large drop in price, given around half the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.5x, you may still consider Xiamen Zhongchuang Environmental Technology as a stock to avoid entirely with its 5.8x P/S ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Xiamen Zhongchuang Environmental Technology Has Been Performing

For instance, Xiamen Zhongchuang Environmental Technology'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. If not, then existing shareholders may be quite nervous about the viability of the share price.

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

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

Retrospectively, the last year delivered a frustrating 28% decrease to the company's top line. As a result, revenue from three years ago have also fallen 70% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 23% shows it's an unpleasant look.

In light of this, it's alarming that Xiamen Zhongchuang Environmental Technology's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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 Bottom Line On Xiamen Zhongchuang Environmental Technology's P/S

A significant share price dive has done very little to deflate Xiamen Zhongchuang Environmental Technology's very lofty 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.

Our examination of Xiamen Zhongchuang Environmental Technology 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. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Xiamen Zhongchuang Environmental Technology that you should be aware of.

If you're unsure about the strength of Xiamen Zhongchuang Environmental Technology's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

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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.

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