Ningbo Donly Co.,Ltd's (SZSE:002164) price-to-sales (or "P/S") ratio of 2.1x might make it look like a buy right now compared to the Machinery industry in China, where around half of the companies have P/S ratios above 3.3x and even P/S above 6x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/S.

What Does Ningbo DonlyLtd's Recent Performance Look Like?

As an illustration, revenue has deteriorated at Ningbo DonlyLtd over the last year, which is not ideal at all. One possibility is that the P/S is low because investors think the company won't do enough to avoid underperforming the broader industry in the near future. However, if this doesn't eventuate then existing shareholders may be feeling optimistic about the future direction of the share price.

Do Revenue Forecasts Match The Low P/S Ratio?

There's an inherent assumption that a company should underperform the industry for P/S ratios like Ningbo DonlyLtd'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 3.0%. As a result, revenue from three years ago have also fallen 8.0% overall. 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 25% growth in the next 12 months, the company's downward momentum based on recent medium-term revenue results is a sobering picture.

With this information, we are not surprised that Ningbo DonlyLtd 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. Even just maintaining these prices could be difficult to achieve as recent revenue trends are already weighing down the shares.

The Key Takeaway

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.

As we suspected, our examination of Ningbo DonlyLtd revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. Right now shareholders are accepting the low P/S as they concede future revenue probably won't provide any pleasant surprises either. 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.

Plus, you should also learn about this 1 warning sign we've spotted with Ningbo DonlyLtd.

Of course, profitable companies with a history of great earnings growth are generally safer bets. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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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.