Chengdu Leejun Industrial Co., Ltd. (SZSE:002651) shareholders would be excited to see that the share price has had a great month, posting a 31% gain and recovering from prior weakness. Unfortunately, despite the strong performance over the last month, the full year gain of 8.4% isn't as attractive.

Since its price has surged higher, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 3.1x, you may consider Chengdu Leejun Industrial as a stock not worth researching with its 10.6x P/S ratio. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Chengdu Leejun Industrial's Recent Performance Look Like?

As an illustration, revenue has deteriorated at Chengdu Leejun Industrial 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Chengdu Leejun Industrial's Revenue Growth Trending?

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

Retrospectively, the last year delivered a frustrating 42% decrease to the company's top line. This means it has also seen a slide in revenue over the longer-term as revenue is down 28% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 26% shows it's an unpleasant look.

With this in mind, we find it worrying that Chengdu Leejun Industrial's P/S exceeds that of its industry peers. Apparently many investors in the company are way more bullish than recent times would indicate and aren't willing to let go of their stock at any price. 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.

The Final Word

Shares in Chengdu Leejun Industrial have seen a strong upwards swing lately, which has really helped boost its P/S figure. 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've established that Chengdu Leejun Industrial currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Unless the recent medium-term conditions improve markedly, investors will have a hard time accepting the share price as fair value.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 3 warning signs with Chengdu Leejun Industrial (at least 1 which is a bit concerning), and understanding them should be part of your investment process.

If these risks are making you reconsider your opinion on Chengdu Leejun Industrial, explore our interactive list of high quality stocks to get an idea of what else is out there.

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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.