Nanhua Instruments Co., Ltd. (SZSE:300417) shares have had a really impressive month, gaining 31% after a shaky period beforehand. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 12% over that time.

Following the firm bounce in price, when almost half of the companies in China's Electronic industry have price-to-sales ratios (or "P/S") below 3.3x, you may consider Nanhua Instruments as a stock not worth researching with its 12.3x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Nanhua Instruments Has Been Performing

As an illustration, revenue has deteriorated at Nanhua Instruments over the last year, which is not ideal at all. 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. 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, Nanhua Instruments would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered a frustrating 21% decrease to the company's top line. As a result, revenue from three years ago have also fallen 67% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

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.

With this information, we find it concerning that Nanhua Instruments 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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Nanhua Instruments' P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

Our examination of Nanhua Instruments 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. 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. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

Having said that, be aware Nanhua Instruments is showing 2 warning signs in our investment analysis, you should know about.

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.

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