Despite an already strong run, Shanghai Welltech Automation Co.,Ltd. (SZSE:002058) shares have been powering on, with a gain of 29% in the last thirty days. 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, Shanghai Welltech AutomationLtd's price-to-sales (or "P/S") ratio of 13.8x might make it look like a strong sell right now compared to other companies in the Electronic industry in China, where around half of the companies have P/S ratios below 4.4x and even P/S below 2x are quite common. 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 Shanghai Welltech AutomationLtd Has Been Performing

Shanghai Welltech AutomationLtd has been doing a good job lately as it's been growing revenue at a solid pace. Perhaps the market is expecting this decent revenue performance to beat out the industry over the near term, which has kept the P/S propped up. If not, then existing shareholders may be a little nervous about the viability of the share price.

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

There's an inherent assumption that a company should far outperform the industry for P/S ratios like Shanghai Welltech AutomationLtd's to be considered reasonable.

Retrospectively, the last year delivered a decent 15% gain to the company's revenues. Still, lamentably revenue has fallen 39% in aggregate from three years ago, which is disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Comparing that to the industry, which is predicted to deliver 27% 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 find it concerning that Shanghai Welltech AutomationLtd is trading at a P/S higher than the industry. It seems most investors are ignoring the recent poor growth rate and are hoping for a turnaround in the company's business prospects. Only the boldest would assume these prices are sustainable as a continuation of recent revenue trends is likely to weigh heavily on the share price eventually.

The Key Takeaway

Shanghai Welltech AutomationLtd's P/S has grown nicely over the last month thanks to a handy boost in the share price. 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.

Our examination of Shanghai Welltech AutomationLtd 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. Unless the the circumstances surrounding the recent medium-term improve, it wouldn't be wrong to expect a a difficult period ahead for the company's shareholders.

It's always necessary to consider the ever-present spectre of investment risk. We've identified 1 warning sign with Shanghai Welltech AutomationLtd, and understanding should be part of your investment process.

If you're unsure about the strength of Shanghai Welltech AutomationLtd'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.