Shenzhen Zqgame Co., Ltd's (SZSE:300052) price-to-sales (or "P/S") ratio of 10.3x may look like a poor investment opportunity when you consider close to half the companies in the Entertainment industry in China have P/S ratios below 5.5x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

How Shenzhen Zqgame Has Been Performing

Recent times haven't been great for Shenzhen Zqgame as its revenue has been rising slower than most other companies. One possibility is that the P/S ratio is high because investors think this lacklustre revenue performance will improve markedly. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

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

The only time you'd be truly comfortable seeing a P/S as steep as Shenzhen Zqgame's is when the company's growth is on track to outshine the industry decidedly.

Retrospectively, the last year delivered virtually the same number to the company's top line as the year before. This isn't what shareholders were looking for as it means they've been left with a 12% decline in revenue over the last three years in total. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Turning to the outlook, the next year should generate growth of 9.9% as estimated by the one analyst watching the company. Meanwhile, the rest of the industry is forecast to expand by 24%, which is noticeably more attractive.

In light of this, it's alarming that Shenzhen Zqgame's P/S sits above the majority of other companies. Apparently many investors in the company are way more bullish than analysts indicate and aren't willing to let go of their stock at any price. Only the boldest would assume these prices are sustainable as this level of revenue growth 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.

Despite analysts forecasting some poorer-than-industry revenue growth figures for Shenzhen Zqgame, this doesn't appear to be impacting the P/S in the slightest. When we see a weak revenue outlook, we suspect the share price faces a much greater risk of declining, bringing back down the P/S figures. Unless these conditions improve markedly, it's very challenging to accept these prices as being reasonable.

It is also worth noting that we have found 3 warning signs for Shenzhen Zqgame (1 is a bit concerning!) that you need to take into consideration.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.