Chengdu Information Technology of Chinese Academy of Sciences Co.,Ltd (SZSE:300678) shareholders are no doubt pleased to see that the share price has bounced 29% 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 24% in the last twelve months.

After such a large jump in price, you could be forgiven for thinking Chengdu Information Technology of Chinese Academy of SciencesLtd is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 13x, considering almost half the companies in China's IT industry have P/S ratios below 3.7x. 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 Has Chengdu Information Technology of Chinese Academy of SciencesLtd Performed Recently?

For example, consider that Chengdu Information Technology of Chinese Academy of SciencesLtd's financial performance has been pretty ordinary lately as revenue growth is non-existent. Perhaps the market believes that revenue growth will improve markedly over current levels, inflating the P/S ratio. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Is There Enough Revenue Growth Forecasted For Chengdu Information Technology of Chinese Academy of SciencesLtd?

Chengdu Information Technology of Chinese Academy of SciencesLtd's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

If we review the last year of revenue, the company posted a result that saw barely any deviation from a year ago. Fortunately, a few good years before that means that it was still able to grow revenue by 15% in total over the last three years. Accordingly, shareholders probably wouldn't have been overly satisfied with the unstable medium-term growth rates.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 20% shows it's noticeably less attractive.

With this in mind, we find it worrying that Chengdu Information Technology of Chinese Academy of SciencesLtd's P/S exceeds that of its industry peers. 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. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

What Does Chengdu Information Technology of Chinese Academy of SciencesLtd's P/S Mean For Investors?

The strong share price surge has lead to Chengdu Information Technology of Chinese Academy of SciencesLtd's P/S soaring as well. 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.

The fact that Chengdu Information Technology of Chinese Academy of SciencesLtd 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 see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Chengdu Information Technology of Chinese Academy of SciencesLtd (at least 1 which makes us a bit uncomfortable), and understanding these should be part of your investment process.

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.