Tongding Interconnection Information Co., Ltd. (SZSE:002491) shares have continued their recent momentum with a 25% gain in the last month alone. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 20% over that time.

Although its price has surged higher, Tongding Interconnection Information may still be sending very bullish signals at the moment with its price-to-sales (or "P/S") ratio of 1.9x, since almost half of all companies in the Communications industry in China have P/S ratios greater than 5.7x and even P/S higher than 10x are not unusual. However, the P/S might be quite low for a reason and it requires further investigation to determine if it's justified.

What Does Tongding Interconnection Information's P/S Mean For Shareholders?

As an illustration, revenue has deteriorated at Tongding Interconnection Information over the last year, which is not ideal at all. It might be that many expect the disappointing revenue performance to continue or accelerate, which has repressed the P/S. Those who are bullish on Tongding Interconnection Information will be hoping that this isn't the case so that they can pick up the stock at a lower valuation.

Do Revenue Forecasts Match The Low P/S Ratio?

Tongding Interconnection Information's P/S ratio would be typical for a company that's expected to deliver very poor growth or even falling revenue, and importantly, perform much worse than 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 14%. As a result, revenue from three years ago have also fallen 1.7% overall. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenue over that time.

In contrast to the company, the rest of the industry is expected to grow by 40% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this information, we are not surprised that Tongding Interconnection Information is trading at a P/S lower than the industry. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

What Does Tongding Interconnection Information's P/S Mean For Investors?

Tongding Interconnection Information's recent share price jump still sees fails to bring its P/S alongside the industry median. We'd say the price-to-sales ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

As we suspected, our examination of Tongding Interconnection Information revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. If recent medium-term revenue trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

You always need to take note of risks, for example - Tongding Interconnection Information has 1 warning sign we think you should be aware of.

If companies with solid past earnings growth is up your alley, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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