SGSG Science&Technology Co., Ltd. Zhuhai (SZSE:300561) shares have continued their recent momentum with a 28% gain in the last month alone. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 23% over that time.

Since its price has surged higher, given around half the companies in China's Electronic industry have price-to-sales ratios (or "P/S") below 3.2x, you may consider SGSG Science&Technology Zhuhai as a stock to avoid entirely with its 31.3x 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.

What Does SGSG Science&Technology Zhuhai's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at SGSG Science&Technology Zhuhai over the last year, which is not ideal at all. 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

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

There's an inherent assumption that a company should far outperform the industry for P/S ratios like SGSG Science&Technology Zhuhai's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 29%. The last three years don't look nice either as the company has shrunk revenue by 48% in aggregate. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 28% shows it's an unpleasant look.

In light of this, it's alarming that SGSG Science&Technology Zhuhai'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.

The Bottom Line On SGSG Science&Technology Zhuhai's P/S

The strong share price surge has lead to SGSG Science&Technology Zhuhai's P/S soaring as well. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

Our examination of SGSG Science&Technology Zhuhai 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with SGSG Science&Technology Zhuhai, and understanding these should be part of your investment process.

If you're unsure about the strength of SGSG Science&Technology Zhuhai'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.