Dongguan Chitwing Technology Co., Ltd.'s (SZSE:002855) price-to-sales (or "P/S") ratio of 3x may not look like an appealing investment opportunity when you consider close to half the companies in the Machinery industry in China have P/S ratios below 2.4x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/S.

What Does Dongguan Chitwing Technology's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Dongguan Chitwing Technology over the last year, which is not ideal at all. One possibility is that the P/S is high because investors think the company will still do enough to outperform the broader industry in the near future. If not, then existing shareholders may be quite nervous about the viability of the share price.

How Is Dongguan Chitwing Technology's Revenue Growth Trending?

There's an inherent assumption that a company should outperform the industry for P/S ratios like Dongguan Chitwing Technology's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 39%. This means it has also seen a slide in revenue over the longer-term as revenue is down 49% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 22% shows it's an unpleasant look.

With this information, we find it concerning that Dongguan Chitwing Technology is trading at a P/S higher than the industry. 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.

The Key Takeaway

Typically, we'd caution against reading too much into price-to-sales ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Dongguan Chitwing Technology currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

Plus, you should also learn about this 1 warning sign we've spotted with Dongguan Chitwing Technology.

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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