When you see that almost half of the companies in the Leisure industry in China have price-to-sales ratios (or "P/S") below 3.1x, Sportsoul Co.,Ltd. (SZSE:001300) looks to be giving off strong sell signals with its 7.4x 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.

How SportsoulLtd Has Been Performing

SportsoulLtd certainly has been doing a great job lately as it's been growing its revenue at a really rapid pace. The P/S ratio is probably high because investors think this strong revenue growth will be enough to outperform the broader industry in the near future. However, if this isn't the case, investors might get caught out paying too much for the stock.

How Is SportsoulLtd's Revenue Growth Trending?

In order to justify its P/S ratio, SportsoulLtd would need to produce outstanding growth that's well in excess of the industry.

Retrospectively, the last year delivered an exceptional 34% gain to the company's top line. However, this wasn't enough as the latest three year period has seen the company endure a nasty 63% drop in revenue in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenues over that time.

Comparing that to the industry, which is predicted to deliver 22% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this in mind, we find it worrying that SportsoulLtd'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 Key Takeaway

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.

We've established that SportsoulLtd 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. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

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

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

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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.