When close to half the companies in the Communications industry in China have price-to-sales ratios (or "P/S") below 3.7x, you may consider Qingdao Eastsoft Communication Technology Co.,Ltd (SZSE:300183) as a stock to potentially avoid with its 4.6x P/S ratio. However, the P/S might be high for a reason and it requires further investigation to determine if it's justified.

What Does Qingdao Eastsoft Communication TechnologyLtd's Recent Performance Look Like?

Revenue has risen firmly for Qingdao Eastsoft Communication TechnologyLtd recently, which is pleasing to see. One possibility is that the P/S ratio is high because investors think this respectable revenue growth will be enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Qingdao Eastsoft Communication TechnologyLtd's Revenue Growth Trending?

The only time you'd be truly comfortable seeing a P/S as high as Qingdao Eastsoft Communication TechnologyLtd's is when the company's growth is on track to outshine the industry.

Retrospectively, the last year delivered an exceptional 16% gain to the company's top line. Revenue has also lifted 16% in aggregate from three years ago, mostly thanks to the last 12 months of growth. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 48% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that Qingdao Eastsoft Communication TechnologyLtd's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 Final Word

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.

The fact that Qingdao Eastsoft Communication TechnologyLtd currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

Having said that, be aware Qingdao Eastsoft Communication TechnologyLtd is showing 3 warning signs in our investment analysis, and 1 of those doesn't sit too well with us.

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.

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