Shenzhen Silver Basis Technology Co., Ltd. (SZSE:002786) shares have continued their recent momentum with a 27% gain in the last month alone. The last 30 days bring the annual gain to a very sharp 70%.

Even after such a large jump in price, there still wouldn't be many who think Shenzhen Silver Basis Technology's price-to-sales (or "P/S") ratio of 2.9x is worth a mention when it essentially matches the median P/S in China's Machinery industry. 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.

How Shenzhen Silver Basis Technology Has Been Performing

For example, consider that Shenzhen Silver Basis Technology's financial performance has been poor lately as its revenue has been in decline. Perhaps investors believe the recent revenue performance is enough to keep in line with the industry, which is keeping the P/S from dropping off. If not, then existing shareholders may be a little nervous about the viability of the share price.

Do Revenue Forecasts Match The P/S Ratio?

In order to justify its P/S ratio, Shenzhen Silver Basis Technology would need to produce growth that's similar to the industry.

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 4.9%. As a result, revenue from three years ago have also fallen 6.3% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

In contrast to the company, the rest of the industry is expected to grow by 26% 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 Shenzhen Silver Basis Technology's P/S exceeds that of its industry peers. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh on the share price eventually.

The Key Takeaway

Shenzhen Silver Basis Technology appears to be back in favour with a solid price jump bringing its P/S back in line with other companies in the industry 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.

The fact that Shenzhen Silver Basis Technology currently trades at a P/S on par with the rest of the industry is surprising to us since its recent revenues have been in decline over the medium-term, all while the industry is set to grow. When we see revenue heading backwards in the context of growing industry forecasts, it'd make sense to expect a possible share price decline on the horizon, sending the moderate P/S lower. If recent medium-term revenue trends continue, it will place shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

It is also worth noting that we have found 3 warning signs for Shenzhen Silver Basis Technology (2 make us uncomfortable!) that you need to take into consideration.

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.