Despite an already strong run, Dongguan Kingsun Optoelectronic Co.,Ltd. (SZSE:002638) shares have been powering on, with a gain of 32% in the last thirty days. Not all shareholders will be feeling jubilant, since the share price is still down a very disappointing 22% in the last twelve months.

After such a large jump in price, given around half the companies in China's Electrical industry have price-to-sales ratios (or "P/S") below 2.1x, you may consider Dongguan Kingsun OptoelectronicLtd as a stock to avoid entirely with its 8.6x P/S ratio. 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 Dongguan Kingsun OptoelectronicLtd Performed Recently?

The revenue growth achieved at Dongguan Kingsun OptoelectronicLtd over the last year would be more than acceptable for most companies. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. If not, then existing shareholders may be a little nervous about the viability of the share price.

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 Dongguan Kingsun OptoelectronicLtd's to be considered reasonable.

If we review the last year of revenue growth, the company posted a worthy increase of 13%. Ultimately though, it couldn't turn around the poor performance of the prior period, with revenue shrinking 69% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 23% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we find it concerning that Dongguan Kingsun OptoelectronicLtd is trading at a P/S higher than the industry. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. There's a very good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with the recent negative growth rates.

The Key Takeaway

Dongguan Kingsun OptoelectronicLtd's P/S has grown nicely over the last month thanks to a handy boost in the share price. It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Dongguan Kingsun OptoelectronicLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. 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.

The company's balance sheet is another key area for risk analysis. Take a look at our free balance sheet analysis for Dongguan Kingsun OptoelectronicLtd with six simple checks on some of these key factors.

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.