Despite an already strong run, Cnlight Co.,Ltd (SZSE:002076) shares have been powering on, with a gain of 61% in the last thirty days. Looking back a bit further, it's encouraging to see the stock is up 54% in the last year.

Since its price has surged higher, given around half the companies in China's Electrical industry have price-to-sales ratios (or "P/S") below 2.5x, you may consider CnlightLtd as a stock to avoid entirely with its 22.1x 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 CnlightLtd's P/S Mean For Shareholders?

CnlightLtd has been doing a decent job lately as it's been growing revenue at a reasonable pace. One possibility is that the P/S ratio is high because investors think this good revenue growth will be enough to outperform the broader industry in the near future. If not, then existing shareholders may be a little nervous about the viability of the share price.

How Is CnlightLtd's Revenue Growth Trending?

CnlightLtd'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.

Retrospectively, the last year delivered a decent 3.6% gain to the company's revenues. Still, lamentably revenue has fallen 25% in aggregate from three years ago, which is disappointing. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

Weighing that medium-term revenue trajectory against the broader industry's one-year forecast for expansion of 25% shows it's an unpleasant look.

With this in mind, we find it worrying that CnlightLtd's P/S exceeds that of its industry peers. 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

CnlightLtd'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.

Our examination of CnlightLtd 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. When we see revenue heading backwards and underperforming the industry forecasts, we feel the possibility of the share price declining is very real, bringing the P/S back into the realm of reasonability. 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.

Before you take the next step, you should know about the 2 warning signs for CnlightLtd (1 is concerning!) that we have uncovered.

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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