Hengli Industrial Development Group Co., Ltd. (SZSE:000622) shares have had a really impressive month, gaining 29% after a shaky period beforehand. But the last month did very little to improve the 52% share price decline over the last year.

Since its price has surged higher, you could be forgiven for thinking Hengli Industrial Development Group is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 7.4x, considering almost half the companies in China's Auto Components industry have P/S ratios below 2.4x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

How Hengli Industrial Development Group Has Been Performing

As an illustration, revenue has deteriorated at Hengli Industrial Development Group over the last year, which is not ideal at all. Perhaps the market believes the company can do enough to outperform the rest of the industry in the near future, which is keeping the P/S ratio high. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is Hengli Industrial Development Group's Revenue Growth Trending?

Hengli Industrial Development Group's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Retrospectively, the last year delivered a frustrating 28% decrease to the company's top line. As a result, revenue from three years ago have also fallen 69% overall. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 24% shows it's an unpleasant look.

With this information, we find it concerning that Hengli Industrial Development Group is trading at a P/S higher than the industry. 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.

What We Can Learn From Hengli Industrial Development Group's P/S?

Shares in Hengli Industrial Development Group 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 Hengli Industrial Development Group currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. With a revenue decline on investors' minds, the likelihood of a souring sentiment is quite high which could send the P/S back in line with what we'd expect. If recent medium-term revenue trends continue, it will place shareholders' investments at significant risk and potential investors in danger of paying an excessive premium.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Hengli Industrial Development Group, and understanding should be part of your investment process.

If you're unsure about the strength of Hengli Industrial Development Group's business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.