Guangdong Topstar Technology Co., Ltd. (SZSE:300607) shareholders would be excited to see that the share price has had a great month, posting a 44% gain and recovering from prior weakness. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 10% over that time.

In spite of the firm bounce in price, Guangdong Topstar Technology's price-to-sales (or "P/S") ratio of 1.4x might still make it look like a buy right now compared to the Machinery industry in China, where around half of the companies have P/S ratios above 2.8x and even P/S above 5x are quite common. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's limited.

How Guangdong Topstar Technology Has Been Performing

While the industry has experienced revenue growth lately, Guangdong Topstar Technology's revenue has gone into reverse gear, which is not great. The P/S ratio is probably low because investors think this poor revenue performance isn't going to get any better. If you still like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

What Are Revenue Growth Metrics Telling Us About The Low P/S?

There's an inherent assumption that a company should underperform the industry for P/S ratios like Guangdong Topstar Technology's to be considered reasonable.

Taking a look back first, the company's revenue growth last year wasn't something to get excited about as it posted a disappointing decline of 17%. Still, the latest three year period has seen an excellent 49% overall rise in revenue, in spite of its unsatisfying short-term performance. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been more than adequate for the company.

Looking ahead now, revenue is anticipated to slump, contracting by 3.4% during the coming year according to the three analysts following the company. That's not great when the rest of the industry is expected to grow by 23%.

In light of this, it's understandable that Guangdong Topstar Technology's P/S would sit below the majority of other companies. However, shrinking revenues are unlikely to lead to a stable P/S over the longer term. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

The Key Takeaway

Guangdong Topstar Technology's stock price has surged recently, but its but its P/S still remains modest. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

It's clear to see that Guangdong Topstar Technology maintains its low P/S on the weakness of its forecast for sliding revenue, as expected. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. Unless these conditions improve, they will continue to form a barrier for the share price around these levels.

Before you settle on your opinion, we've discovered 1 warning sign for Guangdong Topstar Technology that you should be aware of.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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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.