The Ferrotec (An Hui) Technology Development Co.,LTD (SZSE:301297) share price has done very well over the last month, posting an excellent gain of 222%. The annual gain comes to 175% following the latest surge, making investors sit up and take notice.

Since its price has surged higher, you could be forgiven for thinking Ferrotec (An Hui) Technology DevelopmentLTD is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 31.7x, considering almost half the companies in China's Commercial Services industry have P/S ratios below 3.1x. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/S.

What Does Ferrotec (An Hui) Technology DevelopmentLTD's P/S Mean For Shareholders?

Revenue has risen firmly for Ferrotec (An Hui) Technology DevelopmentLTD recently, which is pleasing to see. It might be that many expect the respectable revenue performance to beat most other companies over the coming period, which has increased investors' willingness to pay up for the stock. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Ferrotec (An Hui) Technology DevelopmentLTD's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Ferrotec (An Hui) Technology DevelopmentLTD's to be considered reasonable.

Taking a look back first, we see that the company grew revenue by an impressive 20% last year. Revenue has also lifted 26% in aggregate from three years ago, mostly thanks to the last 12 months of growth. Therefore, it's fair to say the revenue growth recently has been respectable for the company.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 34% shows it's noticeably less attractive.

In light of this, it's alarming that Ferrotec (An Hui) Technology DevelopmentLTD's P/S sits above the majority of other companies. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. 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 recent growth rates.

The Final Word

The strong share price surge has lead to Ferrotec (An Hui) Technology DevelopmentLTD's P/S soaring as well. 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.

The fact that Ferrotec (An Hui) Technology DevelopmentLTD currently trades on a higher P/S relative to the industry is an oddity, since its recent three-year growth is lower than the wider industry forecast. When we observe slower-than-industry revenue growth alongside a high P/S ratio, we assume there to be a significant risk of the share price decreasing, which would result in a lower P/S ratio. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

You should always think about risks. Case in point, we've spotted 2 warning signs for Ferrotec (An Hui) Technology DevelopmentLTD you should be aware of, and 1 of them is concerning.

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.