Huadian Energy Company Limited's (SHSE:600726) price-to-sales (or "P/S") ratio of 1.1x might make it look like a buy right now compared to the Renewable Energy industry in China, where around half of the companies have P/S ratios above 2.3x and even P/S above 5x are quite common. However, the P/S might be low for a reason and it requires further investigation to determine if it's justified.

How Has Huadian Energy Performed Recently?

For instance, Huadian Energy's receding revenue in recent times would have to be some food for thought. Perhaps the market believes the recent revenue performance isn't good enough to keep up the industry, causing the P/S ratio to suffer. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

Is There Any Revenue Growth Forecasted For Huadian Energy?

There's an inherent assumption that a company should underperform the industry for P/S ratios like Huadian Energy'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 3.3%. Even so, admirably revenue has lifted 85% in aggregate from three years ago, notwithstanding the last 12 months. So we can start by confirming that the company has generally done a very good job of growing revenue over that time, even though it had some hiccups along the way.

Comparing that recent medium-term revenue trajectory with the industry's one-year growth forecast of 8.2% shows it's noticeably more attractive.

In light of this, it's peculiar that Huadian Energy's P/S sits below the majority of other companies. It looks like most investors are not convinced the company can maintain its recent growth rates.

What We Can Learn From Huadian Energy's P/S?

It's argued the price-to-sales ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We're very surprised to see Huadian Energy currently trading on a much lower than expected P/S since its recent three-year growth is higher than the wider industry forecast. When we see robust revenue growth that outpaces the industry, we presume that there are notable underlying risks to the company's future performance, which is exerting downward pressure on the P/S ratio. At least price risks look to be very low if recent medium-term revenue trends continue, but investors seem to think future revenue could see a lot of volatility.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 2 warning signs with Huadian Energy, and understanding these should be part of your investment process.

If these risks are making you reconsider your opinion on Huadian Energy, 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.