Thinker Agricultural Machinery Co., Ltd. (SHSE:603789) shares have continued their recent momentum with a 27% gain in the last month alone. Unfortunately, the gains of the last month did little to right the losses of the last year with the stock still down 25% over that time.

Since its price has surged higher, you could be forgiven for thinking Thinker Agricultural Machinery is a stock to steer clear of with a price-to-sales ratios (or "P/S") of 8.7x, considering almost half the companies in China's Machinery industry have P/S ratios below 3.2x. 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.

What Does Thinker Agricultural Machinery's P/S Mean For Shareholders?

Recent times have been quite advantageous for Thinker Agricultural Machinery as its revenue has been rising very briskly. 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. However, if this isn't the case, investors might get caught out paying too much for the stock.

Is There Enough Revenue Growth Forecasted For Thinker Agricultural Machinery?

Thinker Agricultural Machinery's P/S ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the industry.

Taking a look back first, we see that the company grew revenue by an impressive 94% last year. However, this wasn't enough as the latest three year period has seen the company endure a nasty 24% drop in revenue in aggregate. So unfortunately, we have to acknowledge that the company has not done a great job of growing revenues over that time.

In contrast to the company, the rest of the industry is expected to grow by 22% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

In light of this, it's alarming that Thinker Agricultural 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.

What Does Thinker Agricultural Machinery's P/S Mean For Investors?

Thinker Agricultural Machinery's P/S has grown nicely over the last month thanks to a handy boost in the share price. While the price-to-sales ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of revenue expectations.

We've established that Thinker Agricultural Machinery currently trades on a much higher than expected P/S since its recent revenues have been in decline over the medium-term. Right now we aren't comfortable with the high P/S as this revenue performance is highly unlikely to support such positive sentiment for long. Should recent medium-term revenue trends persist, it would pose a significant risk to existing shareholders' investments and prospective investors will have a hard time accepting the current value of the stock.

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

If these risks are making you reconsider your opinion on Thinker Agricultural Machinery, explore our interactive list of high quality stocks to get an idea of what else is out there.

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