United Faith Auto-Engineering Co.,Ltd. (SZSE:301112) shares have had a horrible month, losing 25% after a relatively good period beforehand. Instead of being rewarded, shareholders who have already held through the last twelve months are now sitting on a 34% share price drop.

In spite of the heavy fall in price, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 2.3x, you may still consider United Faith Auto-EngineeringLtd as a stock not worth researching with its 5x 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.

What Does United Faith Auto-EngineeringLtd's Recent Performance Look Like?

For instance, United Faith Auto-EngineeringLtd's receding revenue in recent times would have to be some food for thought. 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.

Do Revenue Forecasts Match The High P/S Ratio?

In order to justify its P/S ratio, United Faith Auto-EngineeringLtd would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered a frustrating 12% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 28% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 22% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that United Faith Auto-EngineeringLtd's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate 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 Key Takeaway

United Faith Auto-EngineeringLtd's shares may have suffered, but its P/S remains high. Using the price-to-sales ratio alone to determine if you should sell your stock isn't sensible, however it can be a practical guide to the company's future prospects.

Our examination of United Faith Auto-EngineeringLtd 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. 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.

Don't forget that there may be other risks. For instance, we've identified 4 warning signs for United Faith Auto-EngineeringLtd (2 make us uncomfortable) you should be aware of.

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.

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