Shanghai Welltech Automation Co.,Ltd. (SZSE:002058) shareholders are no doubt pleased to see that the share price has bounced 25% in the last month, although it is still struggling to make up recently lost ground. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 18% in the last twelve months.

Since its price has surged higher, 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 Shanghai Welltech AutomationLtd as a stock not worth researching with its 7.7x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

How Shanghai Welltech AutomationLtd Has Been Performing

Revenue has risen firmly for Shanghai Welltech AutomationLtd recently, which is pleasing to see. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Shanghai Welltech AutomationLtd's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shanghai Welltech AutomationLtd's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 17% last year. Despite this strong recent growth, it's still struggling to catch up as its three-year revenue frustratingly shrank by 21% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenues over that time.

In contrast to the company, the rest of the industry is expected to grow by 25% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Shanghai Welltech AutomationLtd's P/S sits above the majority of other companies. 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.

What We Can Learn From Shanghai Welltech AutomationLtd's P/S?

The strong share price surge has lead to Shanghai Welltech AutomationLtd's P/S soaring as well. 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.

We've established that Shanghai Welltech AutomationLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

Plus, you should also learn about these 2 warning signs we've spotted with Shanghai Welltech AutomationLtd (including 1 which is significant).

If you're unsure about the strength of Shanghai Welltech AutomationLtd'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.

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