Leon Technology Co., Ltd. (SZSE:300603) shares have continued their recent momentum with a 27% gain in the last month alone. But the gains over the last month weren't enough to make shareholders whole, as the share price is still down 6.6% in the last twelve months.

Following the firm bounce in price, you could be forgiven for thinking Leon Technology is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 6.6x, considering almost half the companies in China's IT industry have P/S ratios below 3.8x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Leon Technology's P/S Mean For Shareholders?

It looks like revenue growth has deserted Leon Technology recently, which is not something to boast about. One possibility is that the P/S is high because investors think the benign revenue growth will improve to outperform the broader industry in the near future. 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?

In order to justify its P/S ratio, Leon Technology would need to produce outstanding growth that's well in excess of the industry.

Taking a look back first, we see that there was hardly any revenue growth to speak of for the company over the past year. Whilst it's an improvement, it wasn't enough to get the company out of the hole it was in, with revenue down 23% overall from three years ago. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 20% 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 Leon Technology'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 Bottom Line On Leon Technology's P/S

The strong share price surge has lead to Leon Technology's P/S soaring as well. 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.

Our examination of Leon Technology 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. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Leon Technology, and understanding should be part of your investment process.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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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.