Despite an already strong run, Shenzhen Deren Electronic Co., Ltd. (SZSE:002055) shares have been powering on, with a gain of 31% in the last thirty days. Longer-term shareholders would be thankful for the recovery in the share price since it's now virtually flat for the year after the recent bounce.

Even after such a large jump in price, Shenzhen Deren Electronic may still look like a strong buying opportunity at present with its price-to-sales (or "P/S") ratio of 1.2x, considering almost half of all companies in the Electronic industry in China have P/S ratios greater than 4.3x and even P/S higher than 9x aren't out of the ordinary. Although, it's not wise to just take the P/S at face value as there may be an explanation why it's so limited.

What Does Shenzhen Deren Electronic's Recent Performance Look Like?

For instance, Shenzhen Deren Electronic's receding revenue in recent times would have to be some food for thought. It might be that many expect the disappointing revenue performance to continue or accelerate, which has repressed the P/S. 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.

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

There's an inherent assumption that a company should far underperform the industry for P/S ratios like Shenzhen Deren Electronic'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 33%. This means it has also seen a slide in revenue over the longer-term as revenue is down 38% in total over the last three years. Accordingly, shareholders would have felt downbeat about the medium-term rates of revenue growth.

In contrast to the company, the rest of the industry is expected to grow by 26% over the next year, which really puts the company's recent medium-term revenue decline into perspective.

With this in mind, we understand why Shenzhen Deren Electronic's P/S is lower than most of its industry peers. However, we think shrinking revenues are unlikely to lead to a stable P/S over the longer term, which could set up shareholders for future disappointment. There's potential for the P/S to fall to even lower levels if the company doesn't improve its top-line growth.

What Does Shenzhen Deren Electronic's P/S Mean For Investors?

Shares in Shenzhen Deren Electronic have risen appreciably however, its P/S is still subdued. 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.

As we suspected, our examination of Shenzhen Deren Electronic revealed its shrinking revenue over the medium-term is contributing to its low P/S, given the industry is set to grow. At this stage investors feel the potential for an improvement in revenue isn't great enough to justify a higher P/S ratio. If recent medium-term revenue trends continue, it's hard to see the share price moving strongly in either direction in the near future under these circumstances.

Before you take the next step, you should know about the 2 warning signs for Shenzhen Deren Electronic that we have uncovered.

If you're unsure about the strength of Shenzhen Deren Electronic'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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