Newonder Special Electric Co.,Ltd. (SZSE:301120) shareholders would be excited to see that the share price has had a great month, posting a 39% gain and recovering from prior weakness. The bad news is that even after the stocks recovery in the last 30 days, shareholders are still underwater by about 8.5% over the last year.

Since its price has surged higher, you could be forgiven for thinking Newonder Special ElectricLtd is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 11x, considering almost half the companies in China's Electrical industry have P/S ratios below 2.4x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Newonder Special ElectricLtd Has Been Performing

As an illustration, revenue has deteriorated at Newonder Special ElectricLtd 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Newonder Special ElectricLtd?

The only time you'd be truly comfortable seeing a P/S as steep as Newonder Special ElectricLtd's is when the company's growth is on track to outshine the industry decidedly.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 27%. As a result, revenue from three years ago have also fallen 2.6% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 23% shows it's an unpleasant look.

In light of this, it's alarming that Newonder Special ElectricLtd'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. 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.

What We Can Learn From Newonder Special ElectricLtd's P/S?

Shares in Newonder Special ElectricLtd have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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 Newonder Special ElectricLtd currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. 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. 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.

Before you take the next step, you should know about the 2 warning signs for Newonder Special ElectricLtd that we have uncovered.

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.