Jikai Equipment Manufacturing Co., Ltd. (SZSE:002691) shares have continued their recent momentum with a 26% gain in the last month alone. Notwithstanding the latest gain, the annual share price return of 6.8% isn't as impressive.

After such a large jump in price, you could be forgiven for thinking Jikai Equipment Manufacturing is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 7.5x, considering almost half the companies in China's Machinery industry have P/S ratios below 3.3x. However, the P/S might be quite high for a reason and it requires further investigation to determine if it's justified.

What Does Jikai Equipment Manufacturing's P/S Mean For Shareholders?

For example, consider that Jikai Equipment Manufacturing's financial performance has been poor lately as its revenue has been in decline. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

How Is Jikai Equipment Manufacturing's Revenue Growth Trending?

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Jikai Equipment Manufacturing's to be considered reasonable.

In reviewing the last year of financials, we were disheartened to see the company's revenues fell to the tune of 15%. Regardless, revenue has managed to lift by a handy 8.1% in aggregate from three years ago, thanks to the earlier period of growth. Although it's been a bumpy ride, it's still fair to say the revenue growth recently has been mostly respectable for the company.

Comparing the recent medium-term revenue trends against the industry's one-year growth forecast of 26% shows it's noticeably less attractive.

In light of this, it's alarming that Jikai Equipment Manufacturing'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. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Jikai Equipment Manufacturing's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

The fact that Jikai Equipment Manufacturing 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 there is a significant improvement in the company's medium-term performance, it will be difficult to prevent the P/S ratio from declining to a more reasonable level.

You always need to take note of risks, for example - Jikai Equipment Manufacturing has 1 warning sign we think you should be aware of.

If these risks are making you reconsider your opinion on Jikai Equipment Manufacturing, 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.