Shanghai Morn Electric Equipment Co., Ltd. (SZSE:002451) shares have had a really impressive month, gaining 28% after a shaky period beforehand. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Although its price has surged higher, it's still not a stretch to say that Shanghai Morn Electric Equipment's price-to-sales (or "P/S") ratio of 2.6x right now seems quite "middle-of-the-road" compared to the Electrical industry in China, where the median P/S ratio is around 2.1x. However, investors might be overlooking a clear opportunity or potential setback if there is no rational basis for the P/S.

What Does Shanghai Morn Electric Equipment's P/S Mean For Shareholders?

We'd have to say that with no tangible growth over the last year, Shanghai Morn Electric Equipment's revenue has been unimpressive. Perhaps the market believes the recent run-of-the-mill revenue performance isn't enough to outperform the industry, which has kept the P/S muted. Those who are bullish on Shanghai Morn Electric Equipment will be hoping that this isn't the case, so that they can pick up the stock at a lower valuation.

Is There Some Revenue Growth Forecasted For Shanghai Morn Electric Equipment?

In order to justify its P/S ratio, Shanghai Morn Electric Equipment would need to produce growth that's similar to 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. However, a few strong years before that means that it was still able to grow revenue by an impressive 44% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been great for the company, but investors will want to ask why it has slowed to such an extent.

Comparing that to the industry, which is predicted to deliver 23% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

In light of this, it's curious that Shanghai Morn Electric Equipment's P/S sits in line with the majority of other companies. Apparently many investors in the company are less bearish than recent times would indicate and aren't willing to let go of their stock right now. They may be setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Key Takeaway

Shanghai Morn Electric Equipment's stock has a lot of momentum behind it lately, which has brought its P/S level with the rest of the industry. 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.

We've established that Shanghai Morn Electric Equipment's average P/S is a bit surprising since its recent three-year growth is lower than the wider industry forecast. When we see weak revenue with slower than industry growth, we suspect the share price is at risk of declining, bringing the P/S back in line with expectations. Unless the recent medium-term conditions improve, it's hard to accept the current share price as fair value.

And what about other risks? Every company has them, and we've spotted 3 warning signs for Shanghai Morn Electric Equipment (of which 2 can't be ignored!) you should know about.

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.