The Wuxi Huadong Heavy Machinery Co., Ltd. (SZSE:002685) share price has softened a substantial 29% over the previous 30 days, handing back much of the gains the stock has made lately. Still, a bad month hasn't completely ruined the past year with the stock gaining 77%, which is great even in a bull market.

In spite of the heavy fall in price, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 3.1x, you may still consider Wuxi Huadong Heavy Machinery as a stock not worth researching with its 6.3x P/S ratio. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so lofty.

How Has Wuxi Huadong Heavy Machinery Performed Recently?

For instance, Wuxi Huadong Heavy Machinery's receding revenue in recent times would have to be some food for thought. 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. If not, then existing shareholders may be quite nervous about the viability of the share price.

Is There Enough Revenue Growth Forecasted For Wuxi Huadong Heavy Machinery?

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

Retrospectively, the last year delivered a frustrating 13% 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 88% in total over the last three years. Therefore, it's fair to say the revenue growth recently has been undesirable for the company.

Comparing that to the industry, which is predicted to deliver 24% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

In light of this, it's alarming that Wuxi Huadong Heavy Machinery's P/S sits above the majority of other companies. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. 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

A significant share price dive has done very little to deflate Wuxi Huadong Heavy Machinery's very lofty P/S. 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.

Our examination of Wuxi Huadong Heavy Machinery revealed its shrinking revenue over the medium-term isn't resulting in a P/S as low as we expected, given the industry is set to grow. 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.

There are also other vital risk factors to consider before investing and we've discovered 2 warning signs for Wuxi Huadong Heavy Machinery that 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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