Guangzhou Haozhi Industrial Co.,Ltd. (SZSE:300503) shares have continued their recent momentum with a 28% gain in the last month alone. Looking back a bit further, it's encouraging to see the stock is up 26% in the last year.

Following the firm bounce in price, when almost half of the companies in China's Machinery industry have price-to-sales ratios (or "P/S") below 3.4x, you may consider Guangzhou Haozhi IndustrialLtd as a stock not worth researching with its 5.6x 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.

What Does Guangzhou Haozhi IndustrialLtd's P/S Mean For Shareholders?

With revenue growth that's exceedingly strong of late, Guangzhou Haozhi IndustrialLtd has been doing very well. 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. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

What Are Revenue Growth Metrics Telling Us About The High P/S?

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

If we review the last year of revenue growth, the company posted a terrific increase of 35%. As a result, it also grew revenue by 10.0% in total over the last three years. So we can start by confirming that the company has actually done a good job of growing revenue over that time.

Comparing that to the industry, which is predicted to deliver 23% growth in the next 12 months, the company's momentum is weaker, based on recent medium-term annualised revenue results.

With this in mind, we find it worrying that Guangzhou Haozhi IndustrialLtd's P/S exceeds that of its industry peers. It seems most investors are ignoring the fairly limited recent growth rates and are hoping for a turnaround in the company's business prospects. There's a good chance existing shareholders are setting themselves up for future disappointment if the P/S falls to levels more in line with recent growth rates.

The Key Takeaway

The strong share price surge has lead to Guangzhou Haozhi IndustrialLtd's P/S soaring as well. 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 Guangzhou Haozhi IndustrialLtd 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 see slower than industry revenue growth but an elevated P/S, there's considerable risk of the share price declining, sending the P/S lower. Unless the recent medium-term conditions improve markedly, it's very challenging to accept these the share price as being reasonable.

Having said that, be aware Guangzhou Haozhi IndustrialLtd is showing 3 warning signs in our investment analysis, and 2 of those can't be ignored.

If strong companies turning a profit tickle your fancy, then you'll want to check out this free list of interesting companies that trade on a low P/E (but have proven they can grow earnings).

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