With a median price-to-sales (or "P/S") ratio of close to 2.2x in the Real Estate industry in China, you could be forgiven for feeling indifferent about Guangzhou Pearl River Development Group Co., Ltd.'s (SHSE:600684) P/S ratio of 2x. While this might not raise any eyebrows, if the P/S ratio is not justified investors could be missing out on a potential opportunity or ignoring looming disappointment.

What Does Guangzhou Pearl River Development Group's P/S Mean For Shareholders?

For example, consider that Guangzhou Pearl River Development Group's financial performance has been poor lately as its revenue has been in decline. It might be that many expect the company to put the disappointing revenue performance behind them over the coming period, which has kept the P/S from falling. 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 P/S?

There's an inherent assumption that a company should be matching the industry for P/S ratios like Guangzhou Pearl River Development Group's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 75%. As a result, revenue from three years ago have also fallen 43% overall. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 12% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we find it worrying that Guangzhou Pearl River Development Group's P/S exceeds that of its industry peers. Apparently many investors in the company are way less bearish than recent times would indicate and aren't willing to let go of their stock right now. There's a 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

Generally, our preference is to limit the use of the price-to-sales ratio to establishing what the market thinks about the overall health of a company.

We find it unexpected that Guangzhou Pearl River Development Group trades at a P/S ratio that is comparable to the rest of the industry, despite experiencing declining revenues during the medium-term, while the industry as a whole is expected to grow. Even though it matches the industry, we're uncomfortable with the current P/S ratio, as this dismal revenue performance is unlikely to support a more positive sentiment for long. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Having said that, be aware Guangzhou Pearl River Development Group is showing 1 warning sign in our investment analysis, you should know about.

It's important to make sure you look for a great company, not just the first idea you come across. So if growing profitability aligns with your idea of a great company, take a peek at this free list of interesting companies with strong recent earnings growth (and a low P/E).

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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.